Dual-path M&A recommendation can hurt retail shareholders

Bidders for Australian listed companies usually decide to make a formal takeover bid or alternatively propose a scheme of arrangement.

But sometimes both paths are taken together and a scheme of arrangement is implemented concurrently with a takeover bid.

For example, the combined scheme and bid approach was used in the Brookfield bid for Healthscope (2019) and the JBS bid for Huon Aquaculture (2020). Then in 2022 there was the CapVest bid for Virtus Health and the KKR/Alludo bid for Nitro Software.

The sting for retail shareholders comes when they follow a target board’s recommendation to accept the concurrent takeover bid before the dual-path transaction has run its full course.

Why use a bid and a scheme?

A bidder needs 90% acceptances in a takeover bid but only 75% shareholder approval for a scheme, to achieve 100% ownership of the target. Where, as in these deals, a rival holds a blocking stake of around 20%, the bidder tries to side-step that stake by encouraging shareholders to vote in favour of their scheme. This encouragement typically involves an earlier and higher payment if the scheme gets up.

But all of these deals also included the fall-back of a concurrent takeover bid containing both a 50% minimum acceptance condition and a “scheme fails” condition.

The dual-track bidders are effectively saying to target shareholders “I will pay you more if I get 100% because the scheme succeeds but I will also pay a little less to obtain less than 100% control.”

Board recommendation can hurt retail shareholders

However, the Nitro deal highlights how a board’s recommendation to accept the takeover bid before the scheme has gone to the vote can hurt retail shareholders.

Late in 2022, Potentia Capital acquired a 19% pre-bid stake and made an unsolicited takeover bid for Nitro Software. Potentia was then over-bid by KKR’s portfolio company Alludo using a combined scheme of arrangement and takeover bid structure.

Complaints about takeover bids are made to the Takeovers Panel, which can declare “unacceptable circumstances” and make corrective orders. Potentia applied to the Panel claiming that it was unacceptable for Nitro to recommend to its shareholders before the Nitro scheme meeting that they vote in favour of the scheme and accept Alludo’s takeover bid for Nitro at the same time.

Instead, the recommendation by Nitro on the takeover bid component of the Alludo proposal should have been that shareholders take no action on the takeover bid until the outcome of the scheme was known. This would avoid the risk of Nitro shareholders being locked into the Alludo takeover bid and unable to accept a higher Potentia bid that might emerge.

All we need is just a little patience…

A wait-and-see recommendation would have made sense for two reasons. Firstly, there was significant doubt about whether the scheme would be passed given Potentia was holding 19% and had publicly stated that it was voting against the scheme. Secondly, Potentia was still in the contest for Nitro and its publicly stated position was that if it could obtain due diligence access to Nitro then it may be able to increase its offer above Alludo’s offer.

The Transaction Booklet for the Alludo proposal warned shareholders that accepting the Alludo takeover bid before the scheme meeting may result in accepting shareholders losing the chance to accept an offer from a competing bidder.

But in reality there was nothing at all for the Nitro shareholders to gain in accepting the Alludo bid before the scheme outcome was known and it had become clear whether Potentia would increase its bid.

Decision by the Takeovers Panel

However, the Panel was reluctant to second guess Nitro’s recommendation. It decided that the warnings given to Nitro shareholders in the Transaction Booklet meant that the recommendation to accept the bid before the scheme meeting was not unacceptable.

Retail shareholders holding 12% of Nitro followed their board’s recommendation and accepted the Alludo takeover bid before the scheme meeting.

After the scheme failed, Alludo declared its concurrent takeover bid unconditional and acquired the 12%. Potentia then increased its offer and Alludo on-sold its 12% to Potentia, pocketing $1,658,745 in profits.

As it turned out, the recommendation harmed the retail Nitro shareholders who had followed their board’s recommendation to accept the bid ahead of the scheme meeting.

Partner Byron Koster acted for Potentia Capital in its bid for Nitro. He was a member of the Takeovers Panel for 12 years.