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The Role of British Purchasers in Corporate Acquisitions

By David W. Heleniak and George Spera

Mr.  Heleniak is a partner and Mr. Spera is an associate at New York’s Shearman & Sterling.

With the pace of corporate acquisitions in the United States continu­ing at historically unprecedented levels, foreign purchasers, and in particular the British, have played an increasingly important role as buyers of America's businesses, most strikingly in the case of public company acquisitions.  This role has been facilitated by the compara­tive ease with which U.K. purchasers have been able to secure equity financing earmarked specifically for particular U.S. acquisitions through underwritten "rights issues." U.S. acquirers have been unable to tap public equity markets here for acquisitions because of timing and disclosure obstacles.  While the U.K. market has not accorded all rights issues a resounding success, a partial catalogue of recent trans­actions financed, at least in part, with rights issues would include Blue Arrow's acquisition of Manpower Inc., Dixons Group's acquisition of Cyclops Corporation, WPP's acquisition of JWT Group, and Boots' acquisition of Flint Labs.

Underwritten rights issues involve the offer of new shares of a U.K. company to its existing shareholders on a pro rata basis.  The advan­tage such issues accord U.K. purchasers arises in part from the ability to synchronize such issues with acquisition transactions in the U.S., in particular acquisitions initiated by a tender offer.  They permit the proceeds of the issue to be available shortly after the acquirer makes a purchase of the target's shares at the conclusion of the tender offer.  Moreover, the U.K. regulatory framework enables British issuers to issue new shares for acquisition purposes without the same degree of disclosure as their U.S. counterparts; in the acquisition context, the principal differences concern pro forma financial statements and other disclosures concerning the impact of an acquisition on an issuer.

Consequently, U.K. companies are able to finance U.S. public compa­ny acquisitions through public equity issues where their U.S. competi­tors, as a practical matter, cannot, and often the U.K. companies can do transactions on a less leveraged basis, at least during the near term, than American purchasers that must initially rely on borrowings to fund their acquisitions and only later attempt to raise equity to reduce indebtedness.  These features of rights offers may help explain the striking success in certain recent transactions of U.K. purchasers who have acquired American enterprises significantly larger than themselves. 

Statutory Framework for Rights Issues.

The issuance of new shares by public English companies is conditioned by the provisions of English law granting preemption rights to shareholders.  The English Companies Act provides that new issues of shares must be offered first to existing shareholders pro rata with their holdings.  There are important qualifications on the preemption right: it applies only when shares are issued for cash, and is circum­scribed strictly by statute. Nevertheless, the existence of preemption rights helps define the options available to an English company seeking to tap the U.K. equity markets to fund a significant acquisition.

Rights issues constitute the prevailing method by which U.K. compa­nies resort to the capital markets to finance foreign acquisitions.  The essentials of a rights issue are straightforward: shareholders are is­sued rights entitling them for a limited period of time to subscribe pro rata to additional shares, almost always at a discount from the then current market price.  The offer must remain open for at least 21 calendar days, after which shareholders either exercise their allotted rights by sending in the required purchase price (in this case the shareholders are said to "take up" the offered shares) or allow their rights to lapse. The issues are invariably underwritten by one or a syndicate of merchant banks, whose obligation to purchase any shares not taken up by the shareholders becomes unconditional upon formal commencement of the rights issue, when "provisional allotment let­ters" informing shareholders of the number of shares to which they may subscribe are dispatched.

Various issues, some of which are raised by the transnational char­acter of a U.S. acquisition, will need to be addressed prior to formal launching of a rights issue.  Potentially sensitive areas include the scheduling of the issue, the need for shareholder approval and the preparation of parallel U.K. and U.S. disclosure documents.  All these matters have consequences for the conduct of the transaction in the United States and require close coordination with the purchaser's U.S. advisors.

Scheduling with the Bank of England

In the United States, issuers are responsible for the scheduling of public offerings of their shares.  While a public offering requires that an effective registration statement be on file with the Securities and Exchange Commission, the Commission, in reviewing and clearing registration statements submitted to it, focuses exclusively on compli­ance with applicable disclosure and related rules, and does not concern itself with the wisdom of launching a particular issue at a particular time.

In Britain, by contrast, the Bank of England is charged with oversee­ing the introduction of new equity issues in an effort to ensure an orderly market for securities.  The issuer must apply to the Bank of England for a date on which it may commence its issue.  Scheduling is a matter of negotiation between the issuer and the "Government broker" representing the Bank of England, and the issuer's place in the queue will depend in part upon the number and size of other proposed issues.

That an issue has been approved for a particular time can raise delicate coordination issues for the company proposing a U.S. acquisi­tion.  If the company is still negotiating with the U.S. target when the time approved for its issue arrives, it may have to reschedule its issue with the Government broker, since announcement of the rights issue at the prearranged time would involve premature disclosure of a possible transaction.

Another possibility, which we discuss later in this article, is that the purchaser may encounter delays or opposition in effecting the acquisi­tion and will not want to risk closing the rights offer when it may have no use to which it can apply the proceeds.  Although practice suggests that the Bank of England has so far been responsive to the needs of companies seeking to reschedule rights issues in the face of changing circumstances, the inability of the issuer to control completely the scheduling of its offer is potentially a complicating factor in an al­ready complex acquisition context.

Shareholder Approval

Rights issues will generally require shareholder approval.  Although, in principle, the directors may by resolution approve a new issue if the company has enough authorized but unissued shares available to satis­fy the requirements of the issue, in the case of a rights issue sharehold­er approval will nevertheless be necessary if the directors wish to "disapply" the statutory preemption provisions to the extent neces­sary, for example, to avoid allocation of fractional shares or to comply with applicable regulatory obligations imposed by overseas jurisdic­tions such as the United States. In the case of smaller companies taking on larger targets, moreover, authorized but unissued shares may not be an adequate source of financing.  And, in any event, the rules of the London Stock Exchange mandate shareholder authoriza­tion for all acquisitions in which the aggregate consideration to be paid exceeds 25 percent of the acquiring company's net assets.

Requirements of shareholder approval have the potential to affect the course of discussions between a U.K. purchaser and an American target significantly.  The U.S. party may be concerned that assurances given by the U.K. company concerning the availability of financing for the acquisition are relatively weak, since the purchaser's rights issue is conditional upon shareholder approval; in an entirely domestic U.S. transaction, a purchaser will ordinarily be expected to have secured firm commitments from its lenders by the time an acquisition agreement is signed.  Conversely, when a transaction is potentially hostile, the purchaser will often send to the target a "bear hug" letter indicat­ing its desire to proceed to an acquisition transaction, inviting the target to enter into negotiations, and (implicitly or overtly) threatening to launch a tender offer if the target does not agree to meet with the purchaser.  The credibility of such a letter depends substantially on the financial ability of the purchaser to proceed with the acquisition.  Again, the requirement of shareholder approval may diminish the effect the purchaser intends to produce.

Against these concerns U.K. purchasers can point to the support that shareholders traditionally accord management in Britain and to the absence of a tradition of contested proxy fights on rights issues.  We are unaware of any rights offer proposed for a U.S. acquisition having been voted down at a general meeting of shareholders.  It should be ob­served, however, that U.K. shareholders have registered unhappiness with certain recent rights issues by declining to take up shares offered to them: the WPP rights issue, for example, was only 35 percent subscribed.  If shareholder reserve can be expressed in the future by voting, it may become more difficult for British purchasers to con­vince their American partners that the requirement of shareholder approval is merely a formality.

Public Announcement

Assuming that the U.K. company's shareholders must approve the rights issue, a notice advising shareholders of the time, place and purposes of the meeting will be mailed, typically at the time of the first public announcement of the company's intention to engage in the transaction.  This public announcement signals the beginning of the public phase of the acquisition in both the United States and Britain, It will have been preceded, in the case of a negotiated transaction, by the discussions leading to the execution of an acquisition agreement and related documents.  The announcement effectively starts the clock run­ning both on the rights offer financing, the principal events of which (shareholders meeting and subsequent rights offer) occur in the U.K., and on the acquisition itself in the U.S.

Shortly after announcement, the U.K. company will distribute to its shareholders proxies to vote at a general meeting of shareholders, together with "listing particulars" setting forth a description of the transaction, financial information concerning the issuer and a descrip­tion of the rights attaching to the securities to be issued.  Prior to distribution, successive drafts of the listing particulars will have been submitted to, commented upon and ultimately cleared by the London Stock Exchange.  Issuers and underwriters are, in the U.K. as in the U.S., liable for material inaccuracies and omissions in the offering documents, and the documents will undergo a rigorous process of verification before being released.

On the U.S. side, if the acquisition is to proceed by way of tender offer, the purchaser will have five business days from its announce­ment to commence the tender offer. The fact that key disclosure documents - listing particulars and an offer to purchase - must be distributed shortly following announcement of a proposed acquisition underscores the need for close coordination between the bankers, law­yers and other advisors working with the purchaser on both sides of the Atlantic.

The disclosure documents of each jurisdiction require information derived from the other: the offer to purchase will describe the rights offer and any other sources of financing for the acquisition and may, depending on the relative sizes of the purchaser and the target, set forth summary financial information about the purchaser, while the listing particulars will describe the U.S. acquisition arrangements, including conditions to the tender offer and any acquisition agreement and related agreements entered into with the target.  Simultaneous preparation in two countries of the necessary disclosure documents is one of the most difficult logistical challenges presented by internation­al transactions of this sort.

U.K. Disclosure

The listing particulars serve a function similar to that of a prospec­tus in a U.S. public offerings Nevertheless, the disclosures required under English law are less extensive than in the United States.  These differences constitute a principal reason why U.K. companies can more quickly and easily tap their domestic equity markets to support a particular acquisition.

One, key British departure from U.S. disclosure requirements in­volves pro forma financial statements.  Under the SEC's Regulation S-­X, when a proposed transaction passes certain thresholds of significance, a registration statement or other disclosure document of the issuer (such as an annual report) must contain pro forma financial statements intended to provide investors with information about the continuing impact of the transaction by showing how it might have affected historical financial statements if consummation of the trans­action had occurred at an earlier time."

Such pro forma financials require considerable time and effort to produce, and are generally impossible without access to the financial records of the subject of the proposed transaction.  The requirement of pro forma financials is a significant element in the difficulty which U.S. purchasers would confront in seeking to raise. equity quickly to finance time sensitive acquisition transactions.

The analogous disclosure obligations of U.K. issuers are less exten­sive.  Listing particulars will describe the business of the target and present summary financial statements for it; in addition, the purchas­er is required to show certain balance sheet items on a combined basis with the target." However, these disclosure obligations can generally be satisfied with information based on publicly available sources con­cerning the target, such as its annual reports.  The difference in re­quired disclosure considerably facilitates for U.K. purchasers the preparation of the documents that must be distributed to potential investors.

Coordination with U.S. Acquisition

We now turn to a consideration of how an acquisition will proceed in the U.S. and the U.K. following public announcement of the purchaser's intention to do the transaction.  Major acquisitions, whether supported or opposed by the management of the company being acquired, are frequently structured as two-step transactions: In a first step tender offer, the purchaser attempts to acquire sufficient shares to enable it-to complete a second-step merger between itself (or one of its affiliates) and the target corporation, as a result of which it will own the entire equity interest of the target.  This structure is favored primarily be­cause of the speed with which a tender offer may proceed, thereby protecting the acquisition against competing offers.

In view of the current preeminence of the two-step structure, we focus on the case in which a U.K. company wishes to pursue a two-step acquisition in the United States, to be funded with the proceeds of a rights issue.

Under the Williams Act, a tender offer must remain open to share­holders of the subject corporation a minimum of 20 business days." As observed above, the purchaser will commence its tender offer in the United States within five business days of public announcement of the transaction, and at approximately the same time will distribute to its shareholders in the United Kingdom notice of a general meeting to approve the rights offer and the transaction, and proxies and listing particulars relating thereto.  Since the issuer is not required to give its shareholders more than 21 calendar days' notice," the meeting can be held within the minimum period that the tender offer must be kept open.  Consummation of the tender offer will be made conditional upon approval of the transactions at the meeting of the acquirer’s shareholders.

After the meeting, but still during the pendency of the U.S. offer, the purchaser will dispatch provisional allotment letters to the sharehold­ers.  It will then be required to wait an additional 21 calendar days from posting until the rights issue can be closed.  Actual receipt of funds may be delayed another few days.  Thus, the elapsed time from initial announcement of the shareholders' meeting until receipt of funds pur­suant to the rights issue will be, at a minimum, on the order of 45 to 50 days.

Since the purchaser ordinarily will not want to keep its U.S. tender offer open for more than the required minimum of 20 business days, the tender offer might be consummated prior to the closing of the rights issue.  The acquirer will accordingly be faced with a need for shortterm financing to enable it to purchase shares tendered in the U.S. tender offer pending receipt of funds pursuant to its U.K. rights issue.  Short-term financing for these purposes is readily available since, as described below, rights issues are underwritten upon the dispatch of provisional allotment letters, which occurs almost immedi­ately after shareholder approval.  If the timetable outlined here is adhered to, such borrowings will be repaid in several weeks upon consummation of the rights offer.

The schedule of events that follow public announcement is relatively stable in the United Kingdom.  In the United States, however, the purchaser may run into complications.  The company may become involved in a contest for control of the target and decide to amend its tender offer, perhaps more than once, to increase the price offered to the target's shareholders.  Each such amendment will require the bid­der to keep the tender offer open for at least ten days from amendment.  In a contested situation, moreover, there is the possibility that the U.K. purchaser will fail to acquire the target.  If the schedule of the rights offer is adhered to in the U.K. and carried to consummation, the purchaser may find that it has received funds for which is has no need and, since it will not have the earnings of the target, it will have depressed its own earnings per share as well.

This problem can sometimes be circumvented by having sharehold­ers who take up rights pay for newly issued shares in installments.  Dixons Group plc followed this approach in its successful acquisition of Cyclops Corporation earlier this year.  Dixons provided for payment of new shares in two installments: an initial installment of 30 percent of the total price and a second installment of 70 percent due three months later.  The second installment was payable only if the acquisition of Cyclops had been consummated or become relatively certain by the payment due date.  Had Dixons not been successful (and there was in fact a competitive bid for Cyclops), Dixons would have retained the proceeds of the first installment and used them for corporate purposes, and the partially paid securities would have been consolidated into fully paid share units.  Thus the dilutive effect of the issue would have been reduced, and Dixons would not have suffered the problem of having raised funds far in excess of its needs.

Underwriting

Rights issues are invariably underwritten by one or a syndicate of U.K. merchant banks.  The obligations of the underwriters customarily become "unconditional" (i.e. there are no further conditions to their underwriting obligations) upon dispatch of provisional allotment let­ters to shareholders." In the case of a U.S. tender offer, the obligations of the underwriters may become unconditional by the time the tender offer closes, since the U.K. issuer often will have conducted its share­holders' meeting and mailed provisional allotment letters to its share­holders during the 20 business day minimum period of the tender offer.

British underwriting practices differ from their American equiva­lents in several key respects.  Whereas the underwriters of a U.S. equity issue generally take title to the entirety of a new issue with a view to the distribution of new shares in the market, the underwriting of U.K. rights issues is typically done on a "standby" basis.

If all new shares are taken up by the shareholders pursuant to the rights issue, the underwriters have no further obligation to the compa­ny. If, as will almost always be the case, some shares are not taken up, then the underwriters are obligated, in the first instance, to endeavor to sell within a specified period of time (which may be as short as one business day) the residual shares in the market at a premium over the amount per share applicable in the shareholder rights issue; the pre­mium over the price to shareholders resulting from such sales is distributed to those shareholders who did not take up the shares of­fered them.  In the event not all shares are subscribed for or sold, the underwriters are committed to subscribe or procure subscribers for the remaining shares.

Situation of U.S. Acquiring Corporations

The U.K. purchaser's ability to raise cash through an equity offering within the time frame of a U.S. tender offer compares favorably with the situation of U.S. acquiring corporations.  The 20 business days during which a first step tender offer remains open will often afford a U.K. purchaser adequate time to conduct a shareholders' meeting approving a rights issue and to gain the unconditional commitment of its underwriters guaranteeing the proceeds thereof.

The same period would in all probability be insufficient for a U.S. issuer to obtain SEC clearance of a registration statement relating to a public offering of shares for cash, and this would undoubtedly be so where the potential acquisition is sufficiently material to the issuer as to require extensive disclosure and pro forma financial information.  As a result, most tender offers involving offers for cash are financed either through the corporate reserves of the purchaser or with borrowings.

In considering the experience of U.K. purchasers of American corpo­rations, we do not mean to suggest that American securities regulation acts as a brake on acquisition transactions.  The continuing number of transactions effected by U.S. purchasers belies any such contention.  The difference between the two systems is largely one of timing and the ability of U.K. public companies to tap equity markets at the outset of an acquisition.  As noted above, even if a U.S. issuer relies on borrow­ings to finance an acquisition, it may be able subsequently to retire acquisition indebtedness through a securities offering.  Nevertheless, an understanding of the different systems of regulation can help ex­plain why initial funding methods of U.S. and U.K. often diverge.