Editor’s Note: Igor Kirman
is a partner in the Corporate Department at Wachtell, Lipton, Rosen & Katz, where he focuses on mergers and acquisitions, corporate governance, and general corporate and securities law matters. This post is based on a Wachtell Lipton firm memorandum by Mr. Kirman, Victor Goldfeld
, and Edward J. Lee
. This post is part of the Delaware law
series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here
The Delaware bar has recently proposed an amendment to the Delaware General Corporation Law that is likely to facilitate the use of tender offer structures, especially in private equity deals. The new proposed Section 251(h), which is expected to be approved by the legislature and governor with an effective date of August 1, would permit inclusion of a provision in a merger agreement eliminating the need for a stockholder meeting to approve a second-step merger following a tender offer, so long as the buyer acquires sufficient shares in the tender offer to approve the merger (i.e., 50% of the outstanding shares, unless the company’s charter provides a higher threshold).
Currently, a two-step merger in which the buyer acquires less than 90% of the target’s shares in the first step tender offer (which would allow it to close the merger almost immediately by the use of Delaware’s short-form merger statute) necessitates stockholder approval of the merger, with its attendant delays and a “fait accompli” stockholder vote. As such possible delays have proved to be a significant deterrent to many tender offers, especially those with private equity buyers who need to close on the first and second steps concurrently in order to facilitate their acquisition financing, the market has evolved a workaround in the form of a “top-up” option. When included in a merger agreement, a top-up option permits the buyer to “top-up” its stake with newly issued shares to reach the required 90% short-form threshold. However, due to the extremely dilutive effect of the top-up issuance, a target company may lack sufficient authorized but unissued shares to ensure that the buyer reaches the needed 90% threshold, thus adding deal uncertainty. To deal with such circumstances, buyers and targets have resorted to other imperfect workarounds, for example a “dual-track” structure in which the parties file a proxy statement while the tender offer is pending (in order to start the clock on SEC review of the proxy statement), and switch to the merger process if the tender offer fails.
The proposed amendment simplifies this landscape by eliminating the need for top-up options and “dual-track” structures in most cases, and also would diminish the use of subsequent offering periods. Although there may be questions about whether the new mechanism will provide incentives for some deal opponents to not tender, since there would be no comparative “cost” to doing so on account of there being no delay in receiving the merger consideration, the changes are expected to facilitate tender offers. The proposed amendment also illustrates the State of Delaware’s commitment to revise its corporate laws to ensure they remain state-of-the-art as inefficiencies are identified through an evolving deal landscape.
The return of the tender offer to deal-making is changing the way that transactions are
accomplished. The list of recent deals using tender offers includes ASP / Gentek, Johnson & Johnson / Omrix, Bankrate / Apax and Parallel Petroleum/Apollo. According to MergerMetrics, 26.15 percent of acquisitions so far this year were structured as tender offers, compared with 16.28 percent in 2007 and 23.34 percent in 2008.
The rise of the tender offer will ultimately spell faster transactions. Tender offers complete in a quicker timetable of a minimum of 20 business days, compared with the two to three months required for a merger. The longer period for a merger is a result of the time needed to file and clear a proxy statement with the Securities and Exchange Commission and stock exchange and state minimum notice requirements for such a vote.
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the legal aspects of mergers, private equity and corporate governance. A former corporate lawyer at Shearman & Sterling, he is a professor at the University of Connecticut School of Law. He is the author of a new book, “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion,” that explores modern-day deals and deal-making.
The tender offer, however, creates certain issues that do not arise in the merger context. These quirks arise mainly because of the two-step nature of the tender offer. In a merger, the shareholders approve the transaction by a 50 percent majority of the shares and the transaction can close immediately thereafter (assuming satisfaction of all other conditions), with the acquirer taking full control and ownership of 100 percent of the target stock.
In a tender offer, however, the acquirer completes the tender offer and purchases majority but not full control. There are always some shares that do not tender into the offer.
To purchase these remaining shares, the acquirer must perform a merger. If the tender offer reaches more than the 90 percent threshold, then under the laws of most states and Delaware no shareholder vote is needed and the merger can occur immediately after the tender offer completion. However, if the acquirer purchases less than 90 percent of the outstanding shares, a shareholder vote must be held to complete this merger. This means that the proxy statement to be filed and cleared and, for a shareholder vote to occur, must run again.
A tender offer is thus a quicker means to control but not necessarily full ownership. With that primer in mind here are some of the issues that are arising as the tender offer becomes ubiquitous:
If an acquirer is financing the acquisition with the target’s cash on hand or debt secured by the target’s assets, the lack of a full ownership “gap” in a tender offer can create problems. The acquirer cannot simply arrange for the target to dividend out any cash, since that dividend would be paid to the still-remaining shareholder who are waiting to be squeezed out.
One way to deal with this issue is to have the target simply loan the acquirer the money from cash on hand or new borrowings. For example, in the recently announced $411 million tender offer by American Securities for GenTek, there is a condition to the obligations of American Securities (or AS) to complete the acquisition that:
(g) GenTek Holding, LLC has not entered into agreements or arrangements on terms acceptable to [AS] providing that, subject to and as promptly as possible following the receipt of funds by GenTek Holding, LLC pursuant to the Debt Financing, GenTek Holding, LLC will loan to [AS], by no later than the date determined by the [AS], all or a portion of such funds in excess of the amount used to repay the existing indebtedness of GenTek, the specific amount of which shall be determined by [AS]…
If an acquirer cannot arrange for a target loan, it can alternatively borrow the money and use the shares purchased as security. However, the margin rules, Regulations U and X, limit a lender’s ability to lend money on margin stock. “Margin stock” includes any publicly traded security (e.g., GenTek stock). A company that wants to do a debt-financed tender offer can get around this problem by structuring the deal to comply with these margin rules and limit the amount of its borrowing to 50 percent of the value of the collateral pledged to secure the loan (i.e., GenTek). But this obviously places a limit on borrowing.
The rise of the tender offer may thus lead to a preference for all-equity financed tender offers with any debt arranged after completion. This trend may be enhanced in middle-market transactions as a result of mistrust of private equity firms by targets to close transactions with debt financing and an accompanying reverse termination fee. Evidence of this comes from the Parallel and Bankrate private equity acquisitions; both used this all-equity model for their tender offers.
Deal lawyers need to be aware that with respect to a tender offer, an index fund may have a policy not tender into an offer if the share price is trading above the offer price no matter the reason.
This sounds like a quaint point, but this is a real issue in a world of active arbitrage. Stocks can trade above the offer price briefly because of this activity, pushing back tender offer expiration dates. Alternatively, because of short-sale settling, stocks can trade above the offer price after the close of the initial offer period and in the subsequent offer period as arbitragers purchase stock to settle short positions. For example, if too many index funds hold your stock, and you are at 89.8 percent, you may have to persuade the funds to sell the stock to get over the hump.
In pharmaceutical deals with contingent value rights, or C..V.R.’s, it can get even more complicated because the market price is almost always above cash offer price because of discounted value of the C.V.R. reflected in market price. This issue is further complicated by the fact that most funds cannot hold C.V.R.’s, so they are stuck between two policies — one telling them they cannot sell while stock is in index or offer price is below market price and the other policy saying they cannot hold C.V.R.’s.
The solution to all of this is recommended in a recent client note David Fox, Daniel Wolf and Susan Zachman of Kirkland & Ellis. They highlight the need to assess index fund ownership early in the tender offer process and work with the funds to arrange a market sale prior to the offer expiration date if their ownership is going to be a problem.
The disconnect between control and full ownership in tender offers has spurred the rise of the top-up. This is an option issued by the target which allows the acquirer to purchase shares from the target after the closing of the tender offer. The top-up typically allows the acquirer to purchase sufficient shares to put the acquirer over the 90 percent level forgoing the need for a shareholder vote if the acquirer only acquires say 60 percent of the shares. According to MergerMetrics, more than 90 percent of tender offers so far this year included a top-up option. You can read more about top-ups in my prior post.
In a recent tender offer, Dainippon Sumitomo Pharma’s offer for Sepracor, a top-up option was provided that was set off when the acquirer achieved only a bare majority of the outstanding shares. This option provided Dainippon the right to purchase that number of shares to maintain a majority of the outstanding shares. The option effectively allowed Dainippon to consummate the merger if it acquired 50 percent of the outstanding shares rather than the more normal formulation of 50 percent of a fully diluted majority (i.e., including options and other rights convertible into common stock).
This meant that Dainippon could obtain full ownership by purchasing less than a full majority of the stock. Nonetheless, this situation was averted when the Dainippon tender offer closed on Tuesday night and Dainippon purchased 78.2 percent of the outstanding Serpacor shares.
There is some talk over whether this type of top-up option is appropriate since it allows acquirers to theoretically gain control when they do not actually have it. I for one feel uncomfortable about it. However, absent some egregious facts and given independent and arms-length bargaining, I am not sure this is a legal issue, at least in Delaware under its standards. The same threshold of a bare majority of outstanding shares applies in mergers. This is merely putting tender offers on parity with mergers. I expect this type of option to spread and become more common in tender offers.