Public Takeovers during the Covid-19 Pandemic
The negative impact of the global pandemic caused by the Coronavirus („Covid-19 pandemic“) has led to historic price collapses on the German stock markets. Whereas the intraday high of the DAX had been as much as 13,795.20 points on February 17, 2020, it reached the low point of 8,255.65 approximately a month later, on March 16, 2020. This 40% drop is proportionally comparable to the negative development triggered by the subprime crisis of 2008. Only the months ahead will tell to which degree this stock price slump adequately reflects the reduced growth perspective of German enterprises or markets are overreacting. There is, however, a good chance that, relative to their „true value“, some companies are presently underrated on the stock market, as markets are right now characterised by high volatility and valuation uncertainty.
This development has several implications for the market for public takeover. Potential bidders could take advantage of attractive entry opportunities created by low stock price levels and companies‘ newly arisen funding and restructuring needs (see section I.). At the same time, fallen stock prices are making listed companies more vulnerable. These companies are therefore being forced to deal with a possible takeover or at least the entry of a new investor (see section II.). Politics have also reacted to the danger of companies in key industries being taken over by implementing increased control of foreign direct investments (see section III.).
I. Opportunities and risks of the crisis from the bidder’s perspective
In analyzing opportunities and risks created by the Covid-19 pandemic, market participants considering a public takeover should particularly bear in mind the following legal aspects.
1. Planning and structuring a takeover
Stakebuilding and offer price: The classical way of stakebuilding in the run-up to a public takeover is purchasing existing shares of the target company on and off the stock ex-change.
Using this method requires observance of the thresholds for voting rights notifications (sections 33 et seq –of the German Securities Trading Act), the first of which is 3% or, for (financial) instruments, 5% of a company’s voting rights. If shares are combined with in-struments, stakebuilding without notification is only permissible for up to 4.99% of the voting rights. Using workaround constructions is difficult and always risky, even if notification of Geely’s investment in Daimler in 2018 was not submitted before a stake of 9.69% had been acquired. While the German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, „BaFin“) did not penalize Geely after the fact, it did amend its FAQs, stating that in such a case it would henceforth assume collusion between the issuing bank and the investor and, consequently, use of an instrument subject to notification requirements,
Stakebuilding may have an impact on the minimum price stipulated by takeover law. The highest price paid in the last six months before publication of the offer document forms one lower limit in determining the minimum price for a takeover or mandatory offer.
The current valuation uncertainties become clearly evident in cases where such prior acquisitions have taken place: If the stock price of the target company does not continue to fall in the future, the bidder will be able to secure a low minimum price level (provided the second parameter, the volume-weighted average price, does not account for a higher minimum price, see „average price and premium rate“ below). Should, however, the price deteriorate further in the future, the bidder will be bound to the minimum price thus determined, at least until the prior purchase ceases to fall within the scope of the aforementioned six-month period.
- Average price and premium rate: In addition to the price of any prior purchase, the so-called 3-month average share price of the target company prior to the announcement of the takeover offer has to be considered as a minimum price. In planning the takeover offer, the development of the stock market price of the target company will therefore have to be analyzed. If prices remain at the present low level, the first takeover bids at a 3-month average share price substantially reduced in contrast to the price level seen in January and February 2020 will be possible in the beginning or middle of June. By that time, the higher market prices prevailing before the plunge caused by the Covid-19 pandemic will for the first time not be considered in calculating the 3-month average share price anymore. The 3-month average prices of potential targets are thus continuing to approach the level of the current low market prices.
Finding the premium on the 3-month average share price necessary for achieving the desired investment amount presents a particular challenge in determining the offer price. This depends, among other things, on the future expectations of the market, which may differ significantly from market expectations before the onset of the Covid-19 pandemic. Many shareholders will have invested in the target at a high price compared to the current low levels. Due to the high purchase price they paid in the past, a proportionally increased premium on diminished share prices might be required to let an offer appear attractive to such shareholders. Should share prices recover, it is necessary to take into account that a takeover offer will usually only be successful if the price offered is higher than the share price at the time the offer is announced. A recovery of the share price of a target company will therefore generally make a potential takeover more expensive.
- Closing conditions: In the current situation, a bidder should also pay special attention to the conditions for the closing of its offer. In the case of voluntary public takeover offers (as opposed to mandatory offers or delisting offers), the bidder has the choice to subject the consummation of its offer to certain conditions, as long as the bidder itself is not able to influence the occurrence of such conditions. By implementing a MAC clause, the bidder can prevent a situation in which it is forced to close its offer even though material adverse circumstances regarding the market or the target company have occurred or become known. According to the regulatory practice of BaFin, closing conditions must have been fulfilled in general before expiry of the acceptance period, the length of which the bidder may set at a minimum of four and a maximum of ten weeks. In particular in the case of longer acceptance periods, including an MAC clause might be necessary in view of continuing uncertainty regarding the development of the economic situation under the impact of the Coronavirus outbreak.
Considering the implications of Coronavirus for the target company, the following MAC clauses would be suitable:
No substantial deterioration of the market environment (so-called Market MAC), e.g. no suspension of trading on the Frankfurt Stock Exchange or no deterioration of a stock market index, i.e. DAX or another suitable index, below a certain number of points.
No substantial deterioration of the target company (so-called Business or Company MAC), e.g. publication of insider information by the target company or occurrence of circumstances which the target company has an obligation to publish as insider information but publication of which is has decided to postpone.
MAC clauses must be designed with particular attention to precision, e.g. with respect to defining the relevant reference parameter for a Business MAC (such as EBITDA). BaFin furthermore demands that when the offer provides for a Business MAC condition an independent assessor is appointed who confirms the occurrence of a substantial deterioration. Against this background, Business MAC clauses in particular are highly complex.
- Share acquisition in the context of capital increases: Companies affected by crises al-ready have or will have an increased need for fresh capital. Where raising debt capital is not possible or desired, there is an opportunity for investors to acquire a stake in the context of a capital increase from authorized capital. This way, investors can subscribe shares in the amount of up to 10% of the share capital of the target company under exclusion of the subscription rights of existing shareholders with a discount of up to 5% on the share price of the target company. Rights issues can also serve as an access point for a new investor, if the investor agrees to a Backstop Commitment, e.g. commits itself to acquire a certain maximum number of new shares not taken up by existing shareholders.
Such share purchases can be combined with a public purchase or takeover offer pursuant to the German Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz; "WpÜG"). Ideally, such an offer should be announced at the same time as the capital measure in order to avoid a share price increase which would then also increase the minimum price. The initial stake acquired in the course of a capital increase can be useful for reaching a potential minimum acceptance threshold on which the completion of a takeover may have been made conditional. However, when combining a capital increase with a takeover offer, it is important to note that the subscription price for the new shares influences the minimum price of the takeover offer (see section „average price and premium amount“ above).
- Due diligence and leak strategy: Almost all public takeovers in Germany are carried out with the support of or at least without active resistance from the administrative bodies of the target company („friendly takeovers“) (see also below „II. Takeover prevention and defense during the crisis – 2. preparatory measures“). Carrying out a due diligence is in many cases also in the interest of the target company and thus basically possible, at least after concessions have been made during negotiation of a so-called Business Combination Agreement. In the context of transactions outside the capital market (private M&A), a focus on the impact of the Covid-19 pandemic on target companies and in particular on their financial situation and any operational changes can be observed in this respect. This trend carries the risk of a more time-consuming due diligence.
This development will probably also influence public takeover transactions, even though these typically require a less comprehensive due diligence. If a due diligence takes more time, a carefully designed Leak Strategy is particularly relevant. Such a strategy regulates in advance possible scenarios and processes to be implemented if a market rumor or an information leak occurs before the takeover offer has been announced. The content of a Leak Strategy, especially drafts of all the respective mandatory and voluntary notifications, must be individually agreed on between the potential investor and the target company.
- Special case: "assumption of control without mandatory offer": To investors that already own a stake below the control threshold of 30% in a publicly listed company, in certain cases an opportunity for a takeover without the requirement to make a mandatory offer might present itself. Such a scenario requires that BaFin grants an exemption from the obligation to make an offer. When a publicly listed company is taken over during a crisis, BaFin has the authority to grant a restructuring exemption, provided there is proof that the target company is in need and capable of being restructured. Furthermore the applicant must commit to making a restructuring contribution, for example by subscribing to a capital increase and/or granting a loan.
2. Performing a takeover
- Coordinating with the stakeholders: In order to keep the circle of insiders prior to a transaction as small as possible, a bidder will as a rule talk with only a small number of people (typically members of the management board and the occasional supervisory board member as well as key shareholders of the target company) before announcing the decision to launch the offer. Apart from that, the bidder will try to make sure that other stakeholders affected by the takeover offer and/or change of control will not be approached before the offer is published.
Experience shows however that close collaboration with lenders is necessary if target companies are weakened by a crisis. The question if taking up contact with lenders before announcing the intention to take over a company makes sense, will have to be assessed in each individual case. Existing loan agreements may, however, contain a change-of-control clause. The risk emanating from such a clause and the financing needs the target might have after the takeover should be analyzed carefully. On the one hand, market interest rates continue to be very low. On the other hand it can be expected that in industries particularly hit by the crisis higher risk premiums will be demanded, a fact which can make refinancing more expensive. Furthermore, banks might tie their willingness to provide financing to a financing contribution by the future major shareholder or generally to an increased equity ratio.
- „Buy-in“ of activist shareholders: Even if hedge funds engaged as long investors in the capital market have also suffered losses from reduced share prices, activist shareholders and particularly hedge funds, are bound to continue playing an important role in public takeovers. The basic possibilities of M&A arbitrage are not changed by the Covid-19 pandemic. A common strategy of this type of investor is to „buy into“ a takeover offer in order to prompt the bidder to increase the offer price or in any case to profit from the ensuing restructuring measures. They usually demand an increase in the offer price on the ground that the target is undervalued by the offer price. In the current market situation, such an assertion is probably easier to get away with than before. This method must be regarded with skepticism, especially when a high acceptance threshold is aimed at. Therefore the choice of the acceptance threshold and the communication strategy of the bidder continue to play a central role.
3. Structural measures
Following a takeover offer, attractive opportunities for subsequent structural measures might present themselves, such as concluding a domination and profit transfer agreement or excluding minority shareholders (squeeze-out). In the context of such structural measures, outside shareholders must be granted a cash compensation, which – in contrast to the minimum price for takeover offers – is based on the fundamental value of the target company (as a rule calculated according to the rules of IDW S1 of the German Institute of Auditors). The currently prevailing low price levels influence the calculation of cash compensations only insofar as the 3-month average price of the shares of a target company before the announcement of structural measure forms the lower threshold for cash compensations.
II. Prevention of takeovers and defense during the crisis
Their increased vulnerability as a consequence of the ongoing crisis forces publicly listed companies to not only tackle urgent issues such as securing liquidity and operational measures but also to deal more in depth with the possibility of their circle of shareholders undergoing chances. This particularly applies to companies that have a large free-float and no key shareholder(s).
The following two scenarios are potentially dangerous:
1. Entry of a hedge fund or an activist investor who, for example, tries to pressure the company to sell attractive parts of the enterprise in the medium or long run for the sake of raking in short-term gains.
2. A takeover offer by a financial investor or strategist: While financing conditions for takeovers may have been affected by the Covid-19 pandemic and strategists are now likely to be preoccupied with their own problems, particularly financial investors still have considerable financial resources available, so that to them, even financing the offer at a higher equity ratio might be acceptable.
1. Preparatory measures
Against this background, the classical measures in preparation for a takeover and investor activism are becoming far more important. The goal of an effective preparation should be to learn as early as possible about the imminent entry of a hedge fund or the intention of a potential bidder to take over the company and thus to be able to prepare an adequate response and avoid being forced to react under time pressure when such a situation arises. At the same time it is of central importance to analyze the impact of the Covid-19 pandemic on one’s own business model and the value of one’s company in order to be able to assess to which degree the decrease in market capitalization during the Covid-19 pandemic has fundamental reasons.
Potential preparatory measures include:
- Observing changes in the shareholder circle (discernible, e.g., via voting rights notifica-tions), trading volume and short sales
- Close contact with institutional investors and other significant shareholders, analysts and the media
- Observing media coverage and statements by hedge funds which have a stake in the company or whose statements have indicated that they might be interested in the company
- Monitoring the recommendations of institutional investors and voting-rights consultants with respect to governance topis (such as remuneration and dividend policy as well as staffing of the administrative bodies of companies during the crisis) in order to recognize any critical points early
- Critical assessment of one’s own company and analysis of potential vulnerabilities inside the company or group with respect to e.g. strategy, balance sheet, tax, corporate governance and other effects triggered or compounded by the Covid-19 pandemic
- Review of all contracts (in particular in the area of financing) which contain a change-of-control clause in order to be able to assess the implications of a successful takeover on the company and the group
- Clear communication with the market regarding medium-term and long-term strategy in order to address criticism based on short-term performance
- Establishment of a defense team and coordination of relevant processes
- Close coordination between management board and supervisory board because ap-proaches will not necessarily be addressed to the management board
- Where appropriate, search for an anchor shareholder who is prepared to provide long-term support to the company during a transformation process
When searching for an anchor investor whom could be offered e.g. a 10% stake from authorized capital excluding subscription rights or from treasury shares, the provisions of corporate law need to be observed:
- If an economic stabilization fund is participating, excluding subscription rights is always adequate and permitted by law.
- If another investor (such as a state fund, pension fund, or any other institutional investor) is to participate in the company, the general criteria apply in assessing if subscription rights may be excluded. Contrary to what critical voice say in stock corporation law literature, it is probably permissible that the management board uses this method to influence the composition of the shareholder circle if this is in the interest of the company (e.g. to cover capital requirements in cases where raising further external capital is not desired or possible) or if, for instance, such a step helps stabilize the company.
- Against the backdrop of increased volatility and insecurity regarding the valuation of public companies, it is probably appropriate to grant the administrative bodies more flexibility when pricing share issuances as would be the case in calmer market phases.
It should also be noted that successful takeovers normally do not take a hostile course in Germany. Occasionally, joint statements by target companies do reject a takeover. Also, the number of neutral statements, which neither reject nor recommend accepting the offer, has grown in recent years (see Noerr Public M&A Reports 01/2018 and 01/2020). However, the bidder will usually try to convince the target company to support the offer. This is especially true in the current situation.
- From the bidder’s perspective there is the danger that the public and staff of the company view the takeover with skepticism if they perceive the bidder to take advantage of the Covid-19 pandemic and the weak position of the target company.
- Due to valuation uncertainty in the current market, the bidder will probably want to carry out a due diligence review of the target company. They will try to form their own opinion of the valuation and the risks of the business of the target company in order to assess if the current discounts on the share price are justified
Due to the above reasons, a potential buyer will probably try to talk with the target com-pany, aiming to secure its support by concluding a business combination agreement. This provides the target with two opportunities to gain some control over the process: First of all, it will have to decide if allowing a potential buyer to perform a due diligence is in the interest of the company. If this is the case and the due diligence and further talks are positive, it is possible to lay down the items significant to the target company in a business combination agreement in advance of the takeover. In doing so, the financing situation after a successful takeover should be addressed, for instance by additional commitments of the bidder.
2. During the takeover
If a bidder discloses its decision to take over a company pursuant to section 10 WpÜG, the provisions of German takeover law regarding a limited neutrality obligation must be observed. These provisions stipulate that the management board of the target company is principally not allowed to take actions which could prevent the offer from being successful.
Important exceptions are:
- actions that a responsible and conscientious managing director would have carried out outside a takeover scenario,
- the search for a competing offer and
- actions approved by the supervisory board of the target company.
These exeptions usually provide the management board of the target company with a certain room for manoeuvre even after a bidder has announced its takeover intention. While simply defending against a takeover as an end in itself is not a permissible corporate strategy, however, according to accurate interpretations, even, for instance, capital measures that make a takeover more difficult can be permissible if they would have been taken outside a takeover scenario anyway and if they are required in order to cover the company’s capital requirements in the given circumstances.
Aside from legal defense measures, the communication of the target company not only with its shareholders but also with all its stakeholders is a decisive element. Part of this communication is the joint statement of the management board and the supervisory board regarding the takeover offer. This statement can also be negative (see above). In view of restrictive tendencies in foreign trade law (see below under IV.), bidders situated outside Europe tend to be disadvantaged to a certain degree.
III. Governmental defense measures against unwanted takeovers
An additional defense measure might become available if there are indications that from an investment control law point of view the takeover might be perceived as a potential danger to public security and order, and that the German Federal Ministry for Economic Affairs and Energy (Bundesministerium für Wirtschaft und Energie; „BMWi“) might in the end refuse to approve the takeover in accordance with sections 55 et seq of the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung; “AWV”) or approve it only under certain conditions, possibly only on the basis of further concessions of the bidder under a public contract. This applies especially for investments that require notification, i.e. in the area of vital infrastructure, defense and IT security management sector. But even in other cases investments might be considered potentially harmful to national security due to the sensitivity of the business activity of the target company or due to the underlying intention of the investor.
Tendency towards more possibilities for government intervention with respect to foreign investments: In view of the Covid-19 pandemic, government action for preventing undesired takeovers has moved even further to the center of legislative and administrative attention. The EU commission, for instance, has urged the member states to examine their existing investment regimes, to adjust them where necessary and to make use of all available possibilities in order to closely examine all holdings of foreign investors in European companies, particularly in areas vital to the state system. At the legislative level, Germany currently uses the fact that the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz; “AWG”) and the AWV are due for reform anyway to implement the industrial strategy and the provisions of the EU Screening Directive adopted in 2019 and to be implemented until October of this year. At the very latest since the CureVac case and the alleged takeover intention by the United States of the leading vaccine manufacturer, the BMWi has woken up and is now carefully examining, with an increasingly restrictive tendency, all foreign investments, announced or unannounced.
In addition, the German Economic Stabilisation Fund Act (Wirtschaftsstablisierungsfondsgesetz; „WStFG“) offers opportunities to prevent liquidity shortfalls and to strengthen the equity base of domestic companies facing problems due to the Covid-19 pandemic. These opportunities may also include a purchase of shares in a company or a takeover of other parts of the assets of such companies if such measures are required to stabilize the company and thus serve to prevent foreign takeovers. To our knowledge, however, the introduction of so-called “golden shares” is not planned at the federal level.
Already strict investment control: In our opinion, further tightening is not required in order to be able to prohibit foreign investments in sensitive areas on grounds of public security and order. For more than 10 years Germany has had one of the stricter investment control regimes worldwide, a regime that allows the BMWi, if necessary in cooperation with further government departments, to restrict or even prohibit a transaction on grounds of public security concerns – independent of the industry in which the target company operates. These rules apply if an investor outside the EU or EFTA purchases 25% or more of the voting rights of a domestic company.
Particularly strict rules for sensitive industries: If a company operates in the area of the vital infrastructures in industries such as energy, water, food, IT and telecommunication, health, finance or insurance, or transport and traffic, to a degree that exceeds individually defined thresholds, a purchase of only 10% or more of the voting rights is sufficient to trigger the implementation of control rights. A notification obligation also applies. The thresholds are more closely defined in the German BSI-KritisV regulation; for instance in the energy sector it is a production of 420 MW or in the food sector an annual production or turnover of 434,500 tons of food. Similar thresholds are defined for the other sectors listed above as well. If the target company develops or produces certain kinds of defense or IT security products (so-called “sector-specific examination”), a purchase of 10% or more of the voting rights is sufficient to trigger controls, however, in such cases even investments from other EU countries require notification and can be prohibited or restricted.
Apart from purchases that require notification, an investor has the opportunity to apply to the BMWi for a certificate of non-objection. The BMWi, however, has the authority to initiate an audit out of its own right. Such an audit is basically a two-step process. In response to the application or notification of an investor, the BMWi in most cases first decides if it wants to initiate a formal audit, then the audit itself may follow. The AWV stipulates strict deadlines: As a rule, the BMWi must complete its prior examination within two months, otherwise the purchase will be deemed approved. The formal audit must be completed within four months as at the filing date of the complete set of required documents, otherwise restrictions or prohibitions cannot be imposed any more. In the area of sector-specific examinations, slightly modified deadlines apply. In practice, complex investment examination procedures might take longer than that: The BMWi argues that it may demand further documents at any time during the audit and thus move the onset of the examination period to a later date. In cases where negotiations of a public contract, which serves to lay down preconditions for the purchase, are initiated, the examination period is interrupted anyway. Especially in the recent past some purchases were prohibited - some were later approved on the basis of public contracts that regulate restrictions, some of the investors abstained from going ahead with their purchases.
Concrete proposals for tighter investment controls: In response to the Covid-19 pandemic, concrete suggestions have been made in Germany for the introduction of further notification obligations in the health sector, for lowering the threshold of what constitutes a risk that requires prohibitions and restrictions, as well as for a prohibition of completing transactions that require notification. In addition, further measures such as a further lowering of the thresholds and an expansion of notification requirements are being discussed but have not yet reached the level of draft legislation and whose implementation might not be required in view of the already rigid system already in place. Investors from non-EU countries should carefully watch tendencies in regulation. Against the background of the implications of investment control, the importance of a thorough analysis of envisaged transactions is growing.
Any questions? Please contact: Dr Volker Land, Dr Michael Brellochs, Dr Stephan Schulz, Dr Bärbel Sachs
Practice group: Capital Markets