One of the competitive advantages that strategic bidders have over financial buyers is the ability to use share consideration as acquisition currency. However, this option became more complicated in 2009 when the Toronto Stock Exchange introduced rules requiring shareholder approval of any issuance of shares for an acquisition that would result in their dilution to existing shareholders of more than 25%. Therefore, a strategic bidder that offers share consideration must make its bid conditional on shareholder approval if the 25% dilution threshold is crossed. This is unappealing, particularly in the context of a hostile takeover, because it adds an element of deal uncertainty and restricts the bidder’s flexibility to increase the share consideration (which may be necessary to make its bid more attractive to the target’s board and/or its shareholders).
To avoid the TSX’s shareholder approval requirement, a strategic bidder will need to structure its bid to offer only cash or a mix of cash and shares. If a bidder makes a cash bid, Canadian takeover bid rules require that the bidder make adequate arrangements before the bid to ensure that it has the necessary funds available to pay for all the securities it has offered to purchase. Conditions in the financing documents are permitted only if the bidder reasonably believes the possibility to be remote that if the bid conditions are satisfied or waived, the bidder will be unable to pay for the securities deposited as a result of a financing condition not being satisfied. Bidders that do not have sufficient cash on hand and that are unable or unwilling to arrange for an acquisition credit facility can raise money for the purchase price in the capital markets. Whereas a concurrent private placement would also be subject to the TSX’s shareholder approval requirement, a public offering will not trigger that requirement (regardless of whether it exceeds the 25% dilution threshold).
Hostile bidders that have financed their bids through public offerings have tended to do so on a "bought deal" basis so that the underwriters are committed to purchasing the securities (subject only to the limited termination rights that are typically granted to underwriters in bought deals, such as the "disaster out"). A bidder that funds a hostile bid by raising money in the capital markets faces the possibility that after having raised the money, its bid will not succeed and it will be left with a large amount of capital that it cannot efficiently deploy. Potential investors may be hesitant to invest if they have concerns over the issuer's ability to use the proceeds of the offering if the takeover bid fails.
To address these concerns, bidders in the Canadian market often use subscription receipt offerings to fund their acquisitions. In a subscription receipt offering, the subscriber pays in full for a subscription receipt that is automatically exchanged for an underlying security of the issuer upon closing of the acquisition. The proceeds of the offering are held in trust until the acquisition closes and the subscription receipts are exchanged for the underlying securities. If the acquisition does not close by a specified date, the subscription price is returned to investors, with interest, and the subscription receipts are cancelled.
Another financing option for strategic bidders is to use extendible convertible debentures, which have features similar to subscription receipts. Debentures of this type have a relatively short initial maturity, often only several months from the issue date. If the acquisition is completed, the maturity date of the debentures automatically extends to what would be a typical maturity date for convertible debentures. If the acquisition does not close, the debentures mature on the initial maturity date, and the principal of the debentures is repaid to investors with interest from the date of issue to the initial maturity date. The debentures are convertible into common shares of the issuer with an implied conversion price set at some level above the market price of the common shares on the date of the offering. As in an offering of subscription receipts, half of the underwriters’ fee is typically payable upon the closing of the offering, and the other half is payable upon the closing of the acquisition. If the acquisition never closes, the underwriters’ fee is reduced by half and the underwriters do not receive the second half of their fee.
WiLAN’s hostile bid for MOSAID Technologies was the first time that extendible convertible debentures were offered to finance an unsolicited takeover bid. On August 23, 2011, WiLAN made an all-cash bid for all the outstanding common shares of MOSAID Technologies. WiLAN proposed to finance C$230 million of the C$480 million purchase price by way of a bought deal public offering of 6% extendible convertible debentures. WiLAN entered into the bought deal letter with the underwriters and filed its preliminary prospectus for the offering on the same day that it publicly announced its intention to make a takeover bid for MOSAID. The offering closed on September 8, 2011, and the takeover bid was initially open for acceptance until September 28, 2011, thereby supplying WiLAN with the funds well in advance of closing. The initial maturity date of the debentures was January 31, 2012, but that date would have been automatically extended to September 30, 2016, if WiLAN had taken up shares under the bid, resulting in WiLAN and its affiliates controlling at least two-thirds of the outstanding MOSAID shares.
A unique innovation of the WiLAN debentures was that WiLAN had the option to extend the initial maturity date to March 31, 2012, in its sole discretion. Given the uncertain and potentially protracted timing of hostile takeover bids, which may go through multiple variations and extensions, this feature mitigates the risk that the initial maturity date will arrive before the expiry of the bid and gives bidders flexibility to pursue their bid strategies without the initial maturity date looming as a hard deadline for the takeup of shares. WiLAN’s bid for MOSAID was eventually topped by a competing bid from U.S. private equity firm Sterling Partners. WiLAN repaid the extendible convertible debentures with interest on the initial maturity date of January 31, 2012.
Extendible convertible debentures offer the same advantage as subscription receipts in that they allow a bidder to raise funds for its bid with the funds being returned to investors if the bid is unsuccessful. One of the advantages of extendible convertible debentures over equity financing is that dilution is delayed until some future date when the bidder’s share price increases beyond the implied conversion price. Debt financing can also be preferable to equity financing for a hostile takeover bid if the bid is being done at a time when the market is depressed or when management believes that the bidder’s shares are undervalued. Issuing public debt can avoid this timing problem and the excess dilution that results from the higher number of shares that would have to be issued to attain the required proceeds when the bidder’s share price is low.
We expect to see more bidders relying on extendible convertible debentures for this reason. In addition, debt financing is particularly appealing in the current low-interest rate environment in which bidders can get attractive interest rates, especially for convertible debentures, which typically have a lower interest rate than non-convertible debentures due to the conversion feature.
Financing a hostile takeover bid with a public offering of extendible convertible debentures, or any other form of security, presents some challenges. The first is that the timing of the offering is coordinated with the launch of the bid: the bought deal letter is signed when the bid is launched and the prospectus must disclose the takeover bid as the use of proceeds of the offering. This means that the bidder must prepare the bought deal offering documents at the same time as the bid documents.
Another challenge is that securities regulation in Canada requires an issuer that files a prospectus and that is proposing to undertake a “significant probable acquisition” to include historical financial statements of the target and pro forma financial information of the combined business. Securities regulators have taken the position that a significant unsolicited takeover bid constitutes a significant probable acquisition – despite the very real possibility, as seen in the WiLAN bid for MOSAID, that the bid may be unsuccessful. Providing financial statements or other financial information about the target is not a problem in a supported transaction on which the target has agreed to cooperate with the bidder regarding financing matters. However, in a hostile takeover bid, the bidder cannot rely on cooperation from the target or its auditors so compiling the required financial information will be more difficult.
An exemption is available from the requirement to include the target’s historical financial statements in a bid circular if the bidder offers its securities directly as consideration for a takeover bid, though pro forma financial information is still required in the circular. However, the prospectus rules that apply when an issuer undertakes a public offering to finance an acquisition have no similar exemption from the requirement to include the target’s historical financial statements in the prospectus. In WiLAN’s offering of extendible convertible debentures, WiLAN requested and received exemptive relief from the requirement to include MOSAID’s historical financial statements in the prospectus; the relief was consistent with the exemption in the takeover bid rules that would have been available if the shares had been offered directly as consideration for the bid. In its prospectus, WiLAN was instead able to refer to MOSAID’s publicly filed financial statements, though the prospectus was still required to include pro forma financial information for the combined business. WiLAN prepared the pro forma information on the basis of MOSAID’s publicly filed financial statements without the cooperation of MOSAID and its auditors.
Despite these challenges, a public offering of extendible convertible debentures is an attractive financing option for bidders seeking to avoid the uncertainty of a shareholder vote and the dilution of an equity issuance. Given the speed at which funds can be raised through a well executed bought deal offering, we expect to see strategic bidders increasingly accessing the public markets to finance hostile takeover bids.
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