What makes an accretive taking-private deal?

By Virginia Tam, K&L Gates
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There is no “one size fits all” strategy for corporate ownership and management. While going public could be the top priority for many private companies, going private, at the right time and sponsored by the right consortium, could be the preferred approach for some listed companies.

Private
Virginia Tam
K&L Gates
Partner, Hong Kong Office

Going private does not mean that the previous going public decision was wrong. Many factors affect what a company would need to remain competitive in its market. Some are within the company’s control, such as business strategy and corporate finance decisions, and some are driven by markets, such as regulatory climate and investor preferences. These factors also change with time. Changes in the global economy could create new opportunities or hurdles previously unforeseen by management and corporate owners. It is therefore prudent for corporate controllers to evaluate the take-private strategy from time to time.

In evaluating whether a take-private transaction is accretive, one should consider the following:

Future operations. Cutting compliance costs should not be the main reason for privatization. Listed companies enjoy various intangible advantages over private ones, such as better market recognition and stronger employee morale. More importantly, does the company rely on the capital markets for its funding needs? Although the company could continue to issue equity and debt securities to investment funds and professional investors after privatization, it would be more difficult and expensive for the company to do so.

Timing. Naturally, a consortium would want to privatize the company at the lowest price possible. This often means launching the deal when equity capital markets are weak, or when the company’s performance is poor. Getting financing under such circumstances, however, is usually more difficult and expensive. Typically, the consortium would want to leverage by using the company stock as collateral. If the company’s performance is poor or faces uncertainties, financial institutions would hesitate to lend, or would require a conservative loan-to-value ratio. Fluctuations and uncertainties in the capital markets could also limit financing options. The “flight to quality” in debt markets could result in fewer debt and mezzanine funds interested in privatizations.

Anchor investors. Who will join the take-private consortium? If the company has several significant shareholders, which one will roll over their interests in the privatization? Will there be new investors? If the consortium will consist of more than one significant member, the parties should seek to agree on control, leverage and exit issues upfront. The lead member, usually the controlling shareholder, should strike a fine balance between the needs for strategic and financing support, and the risks of deadlocks and unrealistic contractual commitments.

Odds of being voted down. In some jurisdictions, privatizations must be approved by disinterested shareholders and the hurdles could be high. For example, for a Hong Kong-listed Cayman company seeking to privatize through a scheme of arrangement, the plan must be supported by more than 75% of disinterested votes cast in the meeting and by a majority of disinterested members present and voting in the meeting; it must also not be objected by more than 10% of disinterested votes cast in the meeting. The sponsor should “run the numbers” and assess the likelihood of the proposal being voted down. This means the sponsor should collect all relevant facts, such as the applicable regulatory thresholds, background of significant shareholders, historical stock prices and operating forecasts of the company. The assessment should be done before significant expenses are incurred for the transaction.

Financing. It is prudent for a sponsor to arrange financing early in the process. Financing support can come from multiple sources: bank facilities, new investments and rollover equity. Each source of funding is available in different forms. For example, new investments can be originated from new investors or existing shareholders, and their forms of investments could include senior debt (such as high-yield notes), mezzanine debt (such as convertible notes) and senior equity (such as preferred stocks). Rollover equity can come from significant shareholders, senior management and the company’s equity ownership plan. The company’s assets can be potentially used as collateral for the financing.

Privatization does not have to be a zero-sum game for the take-private consortium, company management and public shareholders. Although each group takes different things off the table, all could benefit from the same transaction. A successful transaction usually contains the following elements:

Fair dealing. This is evidenced by the arm’s length nature of the transaction terms and the adequacy of the premium to the public shareholders. One should manage public relations carefully so that the public could “see” that a fair dealing is made. Conflicts of interests should be avoided in the whole process, regardless of whether it is mandated by law, and sometimes could go one step further.

Stronger company. Ideally the company should become more efficient and competitive as a result of the privatization, and its employees and executives should be comfortable with the change in status. To achieve this outcome, one should focus on finding consortium members capable of contributing to the different needs of the company after the privatization, such as brand recognition and strategic alliances.

Successful returns. This is achieved by striking the right balance between risks and costs for each investment tier, such that the investment objectives in each tier are fulfilled. Investors should be able to exit at the timeframe originally contemplated and earn a return that broadly correlates with the risks assumed. There should be no unpleasant surprises during the investment period.

Upfront strategic thinking is important because many of the components cannot be adjusted once the deal is launched. We cannot afford to leave the success of a privatization to chance.

Virginia Tam is a partner at K&L Gates’ Hong Kong office. She can be contacted on +852 2230 3535 or by email at [email protected]