Directors face dilemma in fending off unsolicited offers as shareholders strip companies of takeover protection
It’s been a quiet few months for Canadian attorneys, accountants and others who specialize in the arcane art of corporate matchmaking. The number of mergers and acquisitions in Canada hit a six-year low in the first quarter, according to a study by Toronto-based investment boutique Crosbie & Co; there were just 153 transactions in the first three months of the year.
But things may be about to get a whole lot louder for M&A specialists and the corporate boards they serve. The M&A market is poised for an explosion, according to some experts. The post-bubble buying, however, is likely to look a lot different from the cash-rich consolidations that preceded the credit crash.
Boards can expect to field low-ball offers from bargain hunters while enduring magnifying glass-level scrutiny as they contemplate how best to respond to shareholders seething about their shrinking portfolios. If recent months are any indication, the positions some of those board members take on proposed deals will be their last before shareholders toss them out.
A return to boomtown?
The ‘volume of equity issuance in Canada exploded in the first quarter’, reaching $15 billion – its highest level since 2008 – according to an April report on M&A prospects issued by CIBC World Markets. Equity issues have historically preceded a boom in new M&A activity, as companies build war chests to go shopping.
‘Companies are going out and raising funds by selling stock and debt,’ says Frank Arnone, a partner in the securities group and co-chair of the private equity group at Blake Cassels & Graydon. ‘There’s been a huge uptick in financing activity; historically, that means M&A is set to follow.’
Corporate directors have a fiduciary responsibility to obtain the best possible price in the event of a sale when they are representing the target company. But plummeting stock prices have enraged investors and caused a sea change over the last 18 months in the relationship between corporate boards and their shareholders in Canada, says Brad Allen, senior vice president at Laurel Hill Advisory Group. ‘There’s an increasing magnifying lens on the board to make sure it is acting independently and fairly,’ he explains. ‘There are new obstacles that are making it more difficult for directors to execute their fiduciary duties.’
Dissident shareholders are increasingly second-guessing board decisions, finding easy allies among fed-up fellow stockholders to help override them and, in some cases, do away with the board altogether – even when the deals might be good for the company.
Several M&A attorneys point to the bitter proxy fight at HudBay Minerals as a harbinger of things to come. When HudBay’s management sought to take over Lundin Mining last year, a dissident shareholder group led by a Monaco-based hedge fund argued the deal would dilute stock value, rallied others to the cause, and convinced Ontario regulators to override the Toronto Stock Exchange and force the board to bring the deal up for a vote. In the end, the shareholders succeeded in not only scuttling the deal but also ousting the company’s CEO and replacing the entire board.
Ironically, Lundin shares rallied some 276 percent after the deal was derailed, thanks to improving copper prices and reduced liquidity concerns. This prompted HudBay’s new CEO, Peter Jones, to tell a National Post reporter that scuttling the deal may have represented a lost opportunity.
Such shareholder activism has affected the boards of takeover targets, too. Last year Mineralogy Canada made an unsolicited offer for Waratah Coal, whose management recommended against it, Allen says. But shareholder interest convinced them to go back, negotiate a better deal and sell the company. ‘This is becoming more common,’ adds Allen. ‘There have been two or three transactions that have gone off the rails, and those were friendly. You can imagine what can happen with an unfriendly transaction.’
One attorney notes that there were 3,500 withhold votes on directors in the US two years ago, and more than 6,000 last year. Though the full numbers are not yet available for the current Canadian proxy voting season, he and his colleagues anecdotally notice a similar uptick there. ‘On both sides, shareholders are becoming much more involved,’ says Arnone, who represented Mineralogy in the Waratah deal.
Bitterest pill
Increasingly, boards are appointing special committees with their own advisers and legal counsel, as well as independent directors not tied to the company, to gain credibility for their position with shareholders.
The poison pill defense is the most potent tool Canadian boards have to defend against an unsolicited takeover. Often, companies will set up a shareholder rights plan that will spell out what is an accepted bid, defining the hostile bid as unacceptable. Unaccepted bids trigger the issuance of new stock, which causes a massive dilution and prevents the takeover.
In Canada the buying company will usually challenge the poison pill provision, and the security commission or courts will likely grant the defending company a window of time to canvas the market for better offers before allowing the shareholders to vote on the plan, Arnone says. In the vast majority of cases, observers contend, an offer usually results in the sale of the company. It used to be that invoking the poison pill was seen as defending shareholder interests. In the current environment, however, even appointing a special committee and using the poison pill defense can be perilous for boards.
‘The board has to be extremely careful,’ says Susy Monteiro, vice president for proxy services at Georgeson Canada. ‘If it loses that offer, the stock price is going to suffer afterwards. You need to be aware of your shareholders’ composition and where they stand.’
Georgeson recently worked on behalf of a target company facing an unwanted offer. Defending against the bid required rigorous research and outreach to the shareholder community. ‘We spoke to the arbitrage community and got a sense of what it felt the right dollar value was,’ Monteiro says. ‘We felt we needed a superior offer – the stock had traded well above the offer price for a period of time, which definitely worked to our advantage.’
Staying in the loop
In the end, the unwanted buyers walked away and the board stayed in place – but only because it stayed in touch with its constituents. ‘Just making sure our clients had as much information as possible about both types of shareholders helped,’ says Georgeson Canada vice president Chris Makuch. ‘The board knew what different shareholder bases were looking for. It could go with the assumption based on the information it had, that it was unlikely the offer was good enough. That played into its strategy and communications in general. We used the press releases to say that the company was worth more, and that the board would be willing to put the company up for superior offers.’
Such communication, some contend, may be vital for board survival in the months ahead. Even then, however, not everyone is likely to hang onto his or her position.
‘We’re on the front edge of something I think Canada will experience for a year or two,’ says Laurel Hill principal Glenn Keeling. ‘We’re going to see a lot more hostile activity, and boards are going to continue to be challenged. They will be scrutinized like never before.’
