10.2 The initial approach

A prospective acquirer’s initial approach to the target is usually an informal, verbal one conducted between the chairman or senior executives of the two entities (or between respective external financial advisers). The purpose of such approach is to sound-out the target’s appetite for a friendly control transaction. If it transpires that the parties have fundamentally different views on value which are unlikely to be bridged, then the prospective acquirer might decide to leave things at that. But if preliminary discussions indicate that a deal is possible, the prospective acquirer might be encouraged to submit a written proposal.

Written proposals are normally submitted on a confidential, indicative and non-binding basis. There are two key reasons for this.

(a) Confidentiality

First, there are strategic benefits for the prospective acquirer in maintaining the confidentiality of an approach. The submission of a confidential takeover proposal will usually not trigger an ASX announcement obligation on the target’s part. This is because, while a takeover proposal will qualify as price-sensitive information that an ASX-listed target is prima facie obliged to disclose under its ASX continuous disclosure obligations, there is an exception for information that is confidential and concerns an incomplete proposal or negotiation. A confidential, indicative and non-binding proposal falls within the exception.

Notwithstanding that, some companies have in the past voluntarily announced the receipt of a confidential proposal – whether to seek to generate a bidding auction or due to a conservative approach to disclosure, or otherwise. Unfortunately, there is little that a prospective acquirer can do to prevent this. Note that a target’s announcement that it has received an indicative proposal does not usually impose on the prospective acquirer any obligation to proceed with a takeover. Note also that an ASX-listed target is not required, under its continuous disclosure obligations, to announce the receipt of an incomplete and confidential proposal for so long as it remains confidential.

Where the proposal is ‘leaked’ in the media or to the market, confidentiality may be lost and the target will then be obliged to announce the receipt of the proposal.

(b) Due diligence and board recommendation

Secondly, a prospective acquirer is often not willing to be bound to proceed with a takeover unless and until it has had an opportunity to conduct due diligence on the target and has secured the target board’s recommendation , and will be unable to proceed with a scheme of arrangement unless it has secured the target board’s recommendation. As a takeover bid cannot be made subject to a general due diligence condition (see section 7.3(h) above), if there are due diligence issues to be addressed that will need to be done ahead of the offer being announced. There may be other pre-conditions which need to be satisfied, such as the prospective acquirer obtaining indicative financing commitments.

10.3 Due diligence and confidentiality agreement

Given that ASX-listed entities in Australia are subject to fairly extensive reporting requirements and have an obligation to publicly release all price-sensitive information (otherwise known as ‘continuous disclosure obligations’), a preliminary due diligence exercise based solely on publicly available information should give a prospective acquirer a reasonable understanding of the target and of what matters it should probe.

Obviously there are limits to relying on publicly available information. Much information relating to a company’s business is not disclosed either because it is not price-sensitive or is price-sensitive but need not be disclosed due to an exception to the continuous disclosure rules (eg the information is confidential and is generated for internal management purposes or is a trade secret). Information which may not be price-sensitive to an investor and not publicly available can nonetheless be commercially sensitive and of interest to a prospective acquirer. For instance, internal management budgets and forecasts are likely to affect value, as will the existence of change of control provisions in contracts.

A target in most circumstances has no obligation to provide due diligence access to any person, nor to provide a particular level of access once granted. However, it would be consistent with a board’s duty to act in the best interests of shareholders to take reasonable steps to facilitate a proposal that, if implemented, would maximise value for shareholders.

A target will almost always require a prospective acquirer to sign a confidentiality agreement before granting due diligence access. Under a standard confidentiality agreement, the prospective acquirer agrees to keep due diligence information confidential and to use it only for the purposes of a target-recommended transaction.

10.4 Standstill agreement

Under a standstill agreement, the prospective acquirer agrees not to acquire any interest in any securities in the target for a specified period. From the target’s perspective, the standstill agreement serves a number of purposes:

• it enables a target board to enter into discussions knowing that the other party will not then turn hostile on the target, or acquire a stake to attempt to block a competing transaction subsequently recommended by the target board;
• it means that if that other party does then acquire target securities (assuming it can do so without contravening insider trading laws), the target does not have to prove that that party used confidential information in acquiring the shares in breach of the agreement – only that the standstill agreement has been triggered; and
• it provides some protection for the target from potential liability for ‘tipping’ under the insider trading provisions of the Corporations Act – ‘tipping’ is where a person discloses non-public, price-sensitive information to a person who the first person believes would be likely to acquire target shares.

10.5 Pre-bid acquisitions

A prospective acquirer may seek to acquire a ‘pre-bid’ stake in the target (ie. a relevant interest in target securities in advance of acquiring securities under a control transaction). A pre-bid stake can be used as a platform for a hostile takeover bid, or to exert pressure on the target to agree to a deal or to act as a blocking stake against rival bidders. A pre-bid stake can take various forms, ranging from conditional or unconditional security acquisitions to put and call option arrangements to agreements to accept a takeover bid or vote in favour of a scheme.

The key constraints and considerations relevant to a pre-bid acquisition are as follows.

• 20% takeovers rule The prospective acquirer must ensure that it does not have a relevant interest in more than 20% of the target securities, or otherwise voting power of more than 20% in the target, as a result of any pre-bid acquisitions. Otherwise it will breach the 20% rule (see section 2). Negotiations for the acquisition of a pre-bid stake from an existing target shareholder need to be managed to avoid forming any agreement, arrangement or understanding as to how the target shareholder will vote or dispose of the balance of their shares – otherwise the prospective acquirer will become an associate of the target shareholder and the prospective acquirer’s voting power in the target will increase by reference to the target shareholder’s total holding.
• Foreign investment approval requirements If the prospective acquirer is a ‘foreign person’ it may need to obtain Australian foreign investment approval (FIRB approval) to acquire securities in the target (see section 12.1).
• Insider trading If non-public price sensitive information is provided by the target to the prospective acquirer in the due diligence material, technically this would prevent the prospective acquirer from acquiring any target securities. This is because such acquisitions would constitute unlawful insider trading. (Note, though, that the insider trading rules do not prohibit a prospective acquirer from trading in target securities merely because the prospective acquirer intends to make a takeover bid – this is because there is an ‘own intentions’ exception).
• Substantial holding disclosures Where the prospective acquirer holds a relevant interest in 5% or more of the target’s voting securities, or otherwise voting power of 5% or more in the target, as a result of any pre-bid acquisitions, the prospective acquirer will need to disclose its interest via the filing of a substantial holding notice (see section 5). Importantly, a substantial holding notice must have attached to it a copy of all relevant agreements, such as the share purchase agreement or pre-bid acceptance agreement (as applicable). Therefore, where a prospective acquirer seeks to acquire a secret pre-bid stake it should limit itself to less than a 5% interest – however, note that a prospective acquirer’s relevant interests will need to be revealed if the target issues tracing notices on the registered holder of the relevant shares.
• Minimum bid price The price which a prospective bidder or an associate agrees to pay for target securities within the 4 month period before a takeover bid sets a floor price for the bid price (see section 7.3(d)).

10.6 Going on the offensive

For a prospective acquirer’s perspective, the ideal sequence of events is that the target responds favourably to an approach, quickly grants due diligence access and works co-operatively with the prospective acquirer in negotiating and settling a bid or scheme implementation agreement. However, a prospective acquirer should consider its strategic options should the target reject an indicative proposal and the prospective acquirer does not wish to walk away. There are a number of options, including as follows.

(a) Hostile takeover bid

The prospective acquirer can launch a hostile takeover bid and thereby put its proposal directly to target securityholders. The hostile bid option is not suitable for everyone. Certain companies may have a policy or practice of only undertaking friendly deals – hostile deals in Australia can be unpleasant and protracted, and often involve Takeovers Panel proceedings and public relations battles. Also, a hostile bidder needs to be prepared to buy the target without having undertaken detailed due diligence. It is not permissible to make a bid subject to a general due diligence condition, though it is possible to craft due diligence-type conditions linked to objectively determinable outcomes (eg that the target maintain a specified minimum cash position) (see section 7.3(h)). Further, a prospective acquirer that had sought to acquire 100% of the target under a scheme of arrangement will need to be comfortable with the possibility of acquiring less than 100% under a takeover bid if it does not have a 90% minimum acceptance condition or waives such a condition to encourage acceptances (see section 7.3(k)).

(b) Bear hug announcement

The prospective acquirer could unilaterally announce that it has submitted an indicative and non-binding proposal to the target, but stop short of announcing a hostile takeover bid. The announcement would set out the indicative terms and conditions of the proposal, and outline why the prospective acquirer believes it would be favourable for target securityholders. This is known as a ‘bear hug’. The aim is to pressure a target board to engage in negotiations lest it be criticised by its securityholders for failing to do so. The prospective acquirer’s announcement needs to be carefully worded so that it is not considered to trigger the 2-month rule for a takeover bid (see section 7.3(a)).

(c) Board spill

If a prospective acquirer holds 5% or more of a target’s shares it can requisition a general meeting of target shareholders to vote on changes to the target’s board of directors. Obviously, the larger the shareholding, the more likelihood of success at the general meeting.