Target companies push back on M & A delays with hefty break fees

Target companies in M&A deals are increasingly pushing bidders to shoulder far greater regulatory risk.

Target companies are increasingly wary of the risks posed by regulatory approvals, according to MinterEllison partner Alberto Colla (left), pictured here with M&A co-head Con Boulougouris. Picture: Stuart McEvoy

Target companies in M & A deals are increasingly pushing bidders to shoulder far greater regulatory risk, demanding break fees multiples higher than the capped limits placed on buyers.

About 15 per cent of announced deals ultimately failed in the past two years due to regulatory roadblocks, stakeholder activism and buyers’ cold feet, according to a new analysis by MinterEllison lawyers.

And with M & A activity finally picking up after a very subdued 2023, MinterEllison takeovers lawyer Alberto Colla says bidders, activist investors, and target firms are acting on lessons from those collapses, including Brookfield and EIG’s failed $20bn bid for Origin Energy.

Buyers are a lot more vigilant about shareholder activism, competitor manoeuvres, and the need to prepare accordingly.

Target companies are increasingly wary of the risks posed by regulatory approvals, particularly by the foreign investment regulator FIRB – which has intensified scrutiny over transactions involving potential tax avoidance – and the competition regulator ACCC, plus their foreign counterparts, whose reviews can significantly delay deal closures.

“These approvals are taking a lot longer and they are increasingly subject to conditions,” Mr Colla told The Australian.

“Managing regulatory approval risk is now being increasingly pushed to the acquirer in a number of ways … (including) by what’s known as having a ticking fee,” he said, referring to an increase in the offer price for any delay in receiving regulatory approvals beyond a set date.

Listed building materials company CSR last month said it had negotiated a ticking fee as part of its $4.bn sale deal with Saint-Gobain, where the French company committed to pay an extra 2c per month on top of its $9 per share offer if deal completion goes beyond June 26.

Companies have also been using hefty so-called reverse break fees to contractually allocate as much regulatory risk as possible to the prospective acquirer.

Reverse break fees are similar to the traditional break fees payable by targets to compensate a prospective acquirer for expenses and their wasted time if their agreed deal fails due to the emergence of a superior bidder.

Break fees, however, cannot be above 1 per cent, so that rival bidders aren’t discouraged from making competing bids.

But to deal with the growing regulatory risks, target companies are pushing for reverse break fees that are over four times higher than the standard fees paid to bidders.

“There’s no one per cent cap on reverse fees, so we are seeing targets asking bidders to agree to reverse break fees that are substantially higher than the break fee that the target is agreeing to pay the bidder,” Mr Colla said.

“It’s a direct response to the fact that regulatory approvals are now taking a lot longer and the whole time frame for completing transactions is consuming a lot more of everyone’s time, including obviously the target.”

The recently-agreed $9.1bn buyout of Australian tech darling Altium by Japanese semiconductor giant Renesas Electronics is an example of this.

The electronics software maker negotiated a $411m reverse break fee worth about 4.5 per cent of the value of the deal to cushion Altium against the risk of deal failure. In contrast, Renesas is only entitled to a $91m break fee.

The takeover is subject to regulatory approvals by, among others, the Foreign Investment Review Board, the Committee on Foreign Investment in the United States, and competition regulators in Australia, the US, Germany and Turkey.

With deals dragging on, these break fees aren’t just covering regulatory bumps in the road. Companies are looking to use them as a safety net for other things that could mess up a deal closing, like buyers getting cold feet.

Last year’s blockbuster deal between the world’s biggest gold miner Newmont Corporation and Newcrest Mining also included a $US375m break fee, equivalent to approximately 2.2 per cent of Newcrest equity value.

That was payable if Newmont’s board changed its recommendation of the transaction or shareholders voted against it, which did not occur and the deal ultimately proceeded.

So far this year $US16.7bn worth of mergers, acquisitions and divestments have been announced in Australia, down 24 per cent over the same period last year, according to Dealogic data. The total is nonetheless almost double the comparable amount in 2019 and 94 per cent higher than in 2020, before the pandemic hit in March of that year.

About 15 per cent of announced deals ultimately failed in the past two years, including Brookfield and EIG’s $20bn bid for Origin Energy. Picture: Bloomberg/Carla Gottgens

From January 2022 to December 2023, 132 binding private deals were announced and 20 were ultimately unsuccessful, according to the MinterEllison analysis. Others included Albemarle’s failed $6.6bn bid for Liontown Resources and Qantas $614m deal with Aviation Services, which was blocked by the competition regulator and did not include a reverse break fee.

“There are lessons to prospective acquirers … to target boards, and then there are also lessons for key shareholders who are the kingmakers in these transactions,” Mr Colla said.

A key lesson for acquirers – particularly after AustralianSuper built and used its position as Origin’s largest shareholder to block Origin’s deal last year – is the need to have prearranged strategies to deal with activist investors and discourage rival bidders.

“In the increasingly competitive landscape, if you go to market with a single strategy, the risk of failure is higher. And you’ve got to anticipate the sorts of failures that can occur through regulatory risk, through competitor activism, through major shareholder activism,” said Sydney-based partner Shaun Clyne.

As part of that, the lawyers are seeing an increasing use of so-called “dual track” transaction structures that can “neutralise” some of the risks.

The tactic was popularised in 2019 when Brookfield used it to fend off a rival consortium seeking to acquire hospital operator Healthscope and involves having both a scheme of arrangement and a takeover bid running concurrently.

The tactic usually offers the “carrot” of a slightly higher price to those who vote in favour of the proposed scheme, which if turned down can immediately trigger an off-market takeover offer. Its disadvantage is that the bidder will likely end up owning less than 100 per cent of the company.

It is currently being used by J-Power in its $381m takeover bid for Australian renewable energy company Genex Power, in which MinterEllison is an adviser.

“It just raises the bar for those seeking to potentially disrupt a transaction to indicate as a prospective acquirer that you have considered the landscape, anticipated the events and made it a little bit more difficult for those seeking to disrupt,” Mr Clyne said.

J-Power has offered 27.5c a share in cash pending due diligence process, to which Genex has agreed. Also tabled is a back-up offer to secure Genex in the event that not enough of Genex’s shareholders vote in favour of the agreed scheme, amid concerns that Skip Capital, the investment firm of billionaire Scott Farquhar and a one-time Genex suitor, could block the deal.

That offer carries a lower 27c per share cash offer that is conditional on support from Genex shareholders owning at least 50.1 per cent of the Australian renewable energy company.

The MinterEllison analysis outlines other key lessons from past failed deals including learning to engage with key shareholders early to assess support, and qualifying any “best and final” price statements to avoid losing out over small price differences.

It comes as AustralianSuper chief executive Paul Schroder this week called out toxic and “despicable” behaviour behind the scenes during the battle for Origin last year. He said advisers pulled “whatever lever they could” to get a deal over the line during the tussle for energy giant Origin.