The strength of the Australian dollar and recent regulatory developments have given Australian M&A practitioners a few more things to keep in mind. In this edition, we look at the implications of exchange rate movements for takeover bids, lessons from the Panel’s decision on the BC Iron scheme in relation to disclosure of implementation agreements and ASIC’s proposed update to its policy on acquisitions approved by members.
The potential impact of exchange rate fluctuations on takeover bids involving foreign currency
There are several ways in which movements in foreign exchange rates may be important to a party making a takeover bid. While it is uncommon, it is not unheard of for a bidder to choose to denominate their bid in a foreign currency. Notable recent examples include CEMEX’s bid for Rinker Group Limited in 2006 and Barrick Gold Corporation’s bid earlier this year for Equinox Minerals Limited.
A bidder might choose to denominate their bid in a foreign currency because it allows the bidder to cap the total amount to be paid under the bid in the currency in which it receives the majority of its revenue (and so reduce exchange risk) or because the foreign currency is the same in which the target receives the majority of its revenue (and so offers better alignment in terms of value). However, one of the risks of this approach is that it may potentially expose the bidder to risks associated with rapid exchange rate fluctuations. The business of the target may also be particularly sensitive to exchange rate movements, particularly if it is engaged in an activity with an export focus such as mining, and so receives most of its revenue from overseas sales settled in a foreign currency.
The last 12 months have seen considerable movement in the exchange rate of the Australian dollar, particularly as against the US dollar. Overall, there has been a strong upward trend, with the Australian dollar moving from an exchange rate of around 89 US cents in January 2010 to an exchange rate of 109 US cents in April 2011 (moving from approximately 103 US cents to 109 US cents between March 2011 and April 2011 alone) and now sitting slightly below that high. Therefore, it is timely to briefly summarise some of the issues that can arise if a bidder chooses to offer foreign currency as bid consideration or identifies a target with significant foreign exchange exposure.
Making a bid conditional on exchange rate movements
If a bidder is concerned about exchange rate fluctuations impacting on the value of the target, it may choose to make its bid conditional on a particular exchange rate (e.g. the Australian dollar vs the US dollar) remaining above or below a certain level. A bidder will need to be specific about the circumstances triggering the exchange rate condition (e.g. what measure will be used for the relevant exchange rate and at what time will this measure be applied).
The inclusion of a condition stating “there is a deterioration in the exchange rate between the Singapore dollar and Australian dollar of greater than 5%” was challenged before the Takeovers Panel in Skywest Limited 01  ATP 10 because it was not clear when the condition would be triggered. The Takeovers Panel did not have to reach a final ruling on the terms of this condition as the parties agreed between themselves that the condition would be deleted.
However, a foreign exchange condition is a fairly blunt instrument and an alternative might be to have the bid price adjusted for foreign exchange movements. In the takeovers context, this approach would seem to raise a number of difficulties, both legal (such as compliance with the minimum bid price principle discussed below) and practical (such as whether target shareholders will accept a bid where the final bid price could be less than what is offered at the time of acceptance). This view seems to have been confirmed by the result of the recent scheme of arrangement proposed for Redflex Holdings Limited, a company which derived most of its revenue from its US operations.
Under the original proposal offered to Redflex shareholders, the consideration of $2.70 per share to be provided to them would be adjusted according to a sliding scale based on the Australian dollar – US dollar exchange rate on a fixed date after the scheme meeting. This meant all shareholders would receive the same consideration but that they would be asked to vote on the proposed scheme without knowing the exact consideration they would receive (as that would be subject to the exchange rate calculation occuring after the meeting). In response to various concerns, including a surging Australian dollar (which would have meant that the consideration would have been significantly reduced), the proposed scheme was amended so target shareholders were guaranteed to receive a minimum of $2.75 per share plus possible upside based on the exchange rate adjustment to occur after the scheme meeting (which meant that the adjustment mechanism offered no protection to the bidder against exchange rate movements). Despite the improved consideration, the proposed scheme failed to win the support of the required 75% of shareholders at the general meeting held to vote on the scheme.
Minimum bid price principle
In Guidance Note 6, the Takeovers Panel has taken the view that bid consideration offered in a foreign currency should be treated as “non-cash consideration” (because it must be exchanged before Australian shareholders can spend it and its value will vary over time). This means, unless specific ASIC relief is obtained (such as that offered in relation to scrip consideration under ASIC CO 00/2338, which permits the valuation to be made up to five days before dispatch of the offers), the default position will be that a bidder must value the foreign currency consideration offered to target shareholders at the time the offers are made.
While a bidder is not required to offer the same consideration used to acquire a pre-bid stake under its bid, the ‘minimum bid price principle’ in section 621(3) of the Corporations Act means the value of the consideration offered to target shareholders by the bidder under its bid cannot be less than that offered for shares in the target in the four months prior to the date of the bid (which is the date on which offers are made to target shareholders). It follows that, if the bidder purchased a pre-bid stake in Australian dollars and did so within four months prior to the date of the bid, there will be a risk that any appreciation in the Australian dollar in the interim will mean that the bidder will be forced to increase the amount of consideration offered in a foreign currency in order to comply with the ‘minimum bid price principle’.
One way for a bidder to avoid this risk when purchasing a pre-bid stake is to ensure the consideration offered for that stake was in the same currency as the bid consideration. However, this would probably restrict the bidder from being able to buy shares in the target on-market (to the extent that on-market purchases could only be made with Australian dollars) and might also complicate any off-market arrangements the bidder was considering with other substantial shareholders in the target (as those shareholders might be reluctant to assume any currency exchange risk). As ‘non-cash consideration,’ it is possible that the bidder might also be required, under section 636(2) of the Corporations Act, to commission an expert report on the value of the foreign currency offered as consideration in the four months prior to the date of the bid.
In Guidance Note 14, the Takeovers Panel indicated one of the matters it will take into account when determining whether a bidder has sufficient funding for a bid is ‘whether foreign currency funding has been hedged or is enough to ensure that there will be sufficient funds in Australian currency even if there is a material adverse exchange rate movement’.
The Takeovers Panel also indicated in the same guidance note that “additional disclosure regarding any exchange rate risks and their management may also be needed” where the bid consideration comprises foreign currency. In Rinker Group Limited  ATP 35, the Takeovers Panel noted this could include:
- the risk of a significant shift in the value of the relevant exchange rate, which could materially affect the value of the offer in Australian dollar terms; and
- notifying target shareholders receiving bid consideration in foreign currency that:
- the conversion rate used by their bank may be different from the rate identified by the bidder;
- banks may charge a fee for processing foreign exchange transactions; and
- banks may take different times to complete foreign exchange transactions and provide Australian dollar proceeds.
On-market purchases during the bid period
A bidder is not required to offer bid consideration of the same kind as that used to make pre-bid purchases (so a bidder who acquires a pre-bid stake using Australian dollars is not precluded from offering bid consideration in a foreign currency) so long as the bid consideration is of equal value. However, section 651A of the Corporations Act provides that, once the bid is underway, if the bidder purchases shares in the target for cash outside of the bid then shareholders who have already accepted “non-cash” consideration (which would include foreign currency) are automatically given the option to accept for the cash amount paid.
This means that if a bidder offering foreign currency bid consideration purchased shares in the target for cash outside the bid, then target shareholders who had already accepted the foreign currency bid consideration would then have a choice. They could either receive the foreign currency consideration or the Australian dollar amount paid on-market by the bidder, whether or not the Australian dollar amount was of a greater value than the foreign currency consideration being offered. This potentially complicates matters for any bidder who wishes to offer bid consideration in foreign currency while retaining the ability to buy shares in the target on-market.
It is worth noting that the same situation (target shareholder being able choose between the different forms of consideration) would arise if a bidder decided to address a fall in the value of its foreign currency bid consideration by offering an alternative consideration in Australian dollars.
A conversion mechanism?
In order to make foreign currency bid consideration more attractive, a bidder may offer a conversion mechanism (i.e. the opportunity for a target shareholder to receive the equivalent of the foreign currency for which they have accepted in Australian dollars). The key problem a conversion facility may give rise to is that, if there is a floating exchange rate applicable to the conversion of the bid consideration, then target shareholders who elect to receive Australian dollars will not receive the same amount if their consideration is converted at different times (and so potentially at different rates).
The Takeovers Panel decided in Rinker Group Limited  ATP 35 that such a mechanism was not unacceptable per se because it might lead to shareholders receiving different Australian dollar amounts on conversion of the foreign currency bid consideration. However, the Panel required the bidder to provide detailed disclosure of the risks inherent in such an arrangement. It was also necessary for the bidder to obtain relief from ASIC in relation to the requirement in section 619 of the Corporations Act that all of the offers under an off-market bid must be the same (which has been interpreted to mean that the same amount of consideration should be received on acceptance). It is interesting to note that the recent bid by Barrick Gold Corporation for Equinox Minerals Limited did not include a conversion mechanism for the bid consideration (which was denominated in Canadian dollars).
Bids involving foreign currency consideration are rare. This is probably due to the potential issues we have outlined. Also, offering foreign currency bid consideration makes it more difficult to communicate a clear message about value to target shareholders (who will find it easiest to understand a message highlighting a clear premium over the price at which their shares have been trading and what they will receive). Nevertheless, there may be circumstances where a bidder will decide that the additional complexity of offering foreign currency as bid consideration will be worthwhile. It is also increasingly likely that foreign exchange rates will be important factors for bidders assessing the value of Australian targets. In either case, it will be important for such bidders, in light of the volatility of the Australian dollar in recent times, to only proceed with such bids after carefully considering the potential restrictions or pitfalls they may encounter where foreign exchange rates are involved.
This article is from our June 2011 edition of Mergers & Acquisitions newsletter.