UK takeovers and mergers: how they work and how to trade them

What is the City Code and the Panel on Takeovers and Mergers?

The Panel on Takeovers and Mergers is an independent body established in 1968. Its primary role is to enforce the City Code, a binding set of rules that applies to publicly-listed companies in the UK like those on the London Stock Exchange (LSE) and since 2013, AIM.

Takeovers and other M&A transactions are regulated by the Panel. This includes if only one company is UK-based, whether it is being acquired by a foreign company or buying an overseas firm. Companies involved in M&A that are private but have been publicly held within the previous ten years can also find themselves under the Panel’s rule.

An extremely important point to remember about the Panel is that it is not concerned with the financial considerations of any deals – it doesn’t take a view on whether a good offer is being made or not – it simply makes sure everyone is treated fairly and that the process is transparent.

The City Code outlines the rules and principles that those conducting M&A in the UK must follow. These include, but are not limited to, the following:

1. Companies must disclose information (financials, shareholding structure, operational breakdowns etc) in a timely manner through official channels, such as a circular or prospectus, which is made available to all shareholders on an equal basis
2. Those managing the pension schemes of all companies involved must be notified
3. Favourable deals for certain shareholders are banned, all must be treated with equal fairness
4. If a person or business gains control of more than 30% of the voting rights in a business then they must make a cash offer to all other shareholders that is at least equal to the highest paid price in the previous 12 months
5. If a person or business acquires shares in the target company during an offer period then the price offered to all other shareholders must at least match the price paid
6. The target company must appoint an independent advisor to provide advice to shareholders on the financial terms of the deal, which often includes the stance of the board and whether they support it or not

What are the different types of M&A deals?

M&A deals can take very different forms, some of which are far more common than others. Cash and shares are the most popular ways of paying for a deal, contractual agreements are usually how they are facilitated, and most are agreed by both parties before going through. However, there are some others worth noting.

M&A: hostile bids vs recommended deals

If a company decides it wants to buy another company then it has two choices: either making the more traditional approach to the target business to discuss the possibility of a deal, or making a more aggressive push by launching a hostile bid that looks to cut out the management of the target business and deal directly with shareholders.

The preferred way is to secure the backing of the board. This is particularly important if shareholders in the target business support the board and are therefore open to their advice. On the other hand, if there is a strained relationship between the management and the board then the need for the bidding company to secure their approval is lessened, although it still makes the process smoother.

Often, if a company makes an approach, is turned down and then loses interest it is not disclosed to the market and, if a recommended offer is announced then, in reality, the deal has already been struck weeks beforehand.

Once an approach has been made then the target company will consider its answer and negotiate. If they back a deal then they will recommend the offer to shareholders, effectively signing the bid off as the option that gives investors the best value. If not, the bidding company has to decide whether to walk away, negotiate to try to win over the target company’s board, or go over their heads and make a hostile bid directly to the target company shareholders. The two will then battle for shareholder votes, arguing whether the company is better off being bought or staying as an independent business.

M&A consideration: cash and shares

Most M&A deals and takeover bids consist of either cash or shares, or a combination of both. An all-cash deal is straightforward: offering a cash sum on a per share basis. This makes the offer easy to compare to the current or a target share price, or the book value. Some cash offers can see an immediate upfront payment, with the rest being deferred and paid months or years after the transaction has been completed.

Then there is an all-share deal, where no cash consideration is involved. This sees the bidding company offer a certain amount of shares in the business in return for their existing shares in the target company. These offers can be harder to evaluate as the value lies in the shares of the bidding company, and investors have to decide whether they want to hold shares in said company. In this context holding periods are noteworthy as, restriction-free, an investor can receive shares in the bidding company and immediately sell them on the market for cash.

It is common for both to be used as part of a single consideration, giving investors in the target company an immediate reward and a holding in the new enlarged business to offer future growth potential.

How long do takeovers and mergers take to complete?

Takeovers and mergers can theoretically be completed fairly quickly but the larger and more complex deals often take years rather than months because it takes longer to secure regulatory approvals and competition clearance.

It is common for M&A deals to be reported by the media before any formal announcement has been made by either the bidding or target company. This can often lead to share price volatility. If enough volatility is experienced or the companies have requested so beforehand share prices can be suspended pending an announcement declaring the proposed deal.

Usually, the first announcement will be an unbinding one that simply states a potential offer could be made (sometimes with a guide price but most often not), and who the bidder is. The bidding company then has 28 days to announce it has a firm intention of making an offer or has no intention of making an offer and will walk away – also known as the ‘put-up or shut-up’ clause. Any offer must remain open for at least 14 days, which starts fresh each time a new or revised bid is made.

The deadline can be extended on the agreement of both parties if more negotiations are needed, which is often why deals are prolonged in nature.

Investors in the target company then decide whether they want to accept the offer or not and, if the bidding company secures enough acceptances, it can be declared unconditional. The other way shareholders respond to an offer is by voting at a general meeting, when again a certain support threshold must be met for the deal to go through.

What is a scheme of arrangement?

The traditional M&A deal, as described above, is led by the bidding company that takes responsibility for communicating with and putting their offer to target company shareholders. However, another way for a deal to be proposed to investors is through a scheme of arrangement which sees the management of the target company propose the offer to its own shareholders on behalf of the bidder.

Takeovers: scheme of arrangement vs contractual offers

Usually a target company will use a scheme of arrangement because they support an offer. Bidding companies are much more likely to gain the support of target company shareholders if the board recommends it, which tends to make the process quicker and subdue any debate. The usual takeover process can be a long one as much more negotiation and debate needs to be had.

M&A and takeovers: how are hostile and contested bids resolved?

If a hostile bid is to go through then it ultimately comes down to either securing enough acceptances or winning enough votes of target company shareholders during a meeting. This remains true for contested bids, when more than one company vies for a single target, but the process tends to be much longer as investors are not asked for their opinion until after the rival bidders have fought it out.

The acquisition of Sky is a perfect example not only of how the rare procedure used to resolve never-ending battles over a business works but also the rewards of contested bids. Sky was under offer for over two years in total and the fight between Comcast and 21st Century Fox was ultimately decided by a final auction process, something that has been in place since 2000.

With neither firm declaring their bid for Sky as best and final, the Takeover Panel launched a three-round bid process. Through a secure web portal, Comcast and Fox made a first bid which was then revealed to one another. They were then allowed to make a second bid which they then responded to a third a final time: the higher of which wins.

It is a fascinating process that acts like a dramatic ending to a long-drawn novel, but one filled with skill and front. The bids cast in the first two rounds were reported as being only ‘pennies’ in difference as both Comcast and Fox kept their cards close to their chest until the third and final round with the aim of surprising their rival with an unbeatable offer – the maximum they were willing to pay for the business.

The result? Despite issuing virtually the same bids in the first two rounds, Comcast ended up paying considerably more for Sky when the results of the final round were released, paying £17.28 per share compared to Fox’s final offer of £15.67. Sky shareholders not only did well out of the contested bid as a whole (with its share value more than doubling), but were also ensured maximum value through the blind auction process – Comcast’s first offer for Sky was just £12.00.

M&A shareholder thresholds: it’s not all about takeovers

M&A is not all takeovers and acquiring entire businesses but also about businesses investing in others, either for strategic or financial gain. Obviously, shareholders with greater stakes and voting rights hold greater control or influence over the business and this is regulated in the same way. Although it is common for big companies to purchase small ones outright without necessarily investing in that business beforehand, it is also common for a bidding company to have built up some form of stake in the target firm before launching an offer.

The rules and consequences of a bidding company holding a particular-sized stake in the target firm before making an offer are detailed in the table below:

The 30% threshold is particularly notable. A company holding a 29.9% stake in another is not uncommon nor coincidental. This is because (in most cases) they cannot own more than 30% of the business without having to make an offer for the entire company. These high stakes can be strong precursors to possible M&A activity, especially if it has involved stake-building, when a business steadily buys more shares over a longer period of time.

This demonstrates the importance of the thresholds set. Here is an example: Cooker Co has been struggling and fighting off attempts from rival Baker Co for years and now, following some bad news, its stock has collapsed. As shares are sold off at rock-bottom prices Baker Co can just buy shares as they become available on the market and own a controlling interest before you know it – leaving the other shareholders in the dark. These thresholds, like the 30%, stop businesses taking over others without making a bid to the other investors and stops firms from acquiring major influence if they aren’t willing to pay the price and manage it.

Sports Direct is a good example, having invested material sums in rival high street shops. The company’s holding in House of Fraser allowed it to take over the business when it went bust and, if it wasn’t for that, Sports Direct was (and still is to a degree) expected to use its stake in Debenhams to launch a takeover bid.

UK M&A: the Competition and Markets Authority

The Competition and Markets Authority’s (CMA’s) single job when looking at M&A activity in the market is to decide whether any mergers, acquisitions, joint ventures or other deals will lessen competition in any way. For many, the CMA process is a necessary but more procedural one, but for some (usually the largest ones) the CMA’s approval is crucial as it has the power to prohibit a deal if it deems it detrimental to competition.

There are two ‘investigations’ that are conducted by the CMA to determine whether it approves a deal and one carries a lot more risk than the other. A phase one investigation is standard and simply determines whether the CMA needs to consider looking into a deal. Unlike in other markets, there is no obligation for businesses to inform the CMA before agreeing any deal, although it is common practice to liaise with the body rather than get caught out down the line (it can prohibit and unwind a merger even if it has already been completed). As a general but broad rule, if the target company generates over £70 million in annual revenue or if a deal results in the new enlarged business holding more than 25% of any given market then the CMA will conduct a phase one investigation.

This means most UK deals among the corporate giants of the world attract the CMA’s interest, but this is expected. The CMA has 40 days (unless it extends it) to close the first investigation or launch a phase two investigation, which is an entirely different kettle of fish. An announcement of a phase two investigation sends a strong signal of doubt that the deal will get clearance as it means the CMA has reason to believe it could harm competition.

More often than not a phase two investigation results in remedies and undertakings being implemented, rather than an outright ban on any deal whatsoever. For example, Wood Group was already the market leader in the UK North Sea but the acquisition of Amec gave it too much control in the area, so the CMA only allowed the merger to complete if Amec’s operations were sold-off first.

The CMA will make it clear what its concerns about a deal are before making a ruling and companies can look to alleviate these by submitting undertakings, which are commitments to do something if the merger is cleared, such as selling off a business. The CMA’s final report will outline its findings in detail and make a final decision, sometimes with certain conditions, and its involvement understandably extends the takeover timetable.

How will Brexit impact UK mergers and acquisitions?

Jurisdiction over the regulation of takeovers and investigations of M&A activity in Europe is complex. Although overseen by the EC, most deals are still analysed at a national level by individual member states that have their own versions of the CMA. However, the CMA, or the companies being investigated by the CMA, can refer the deal in question to the EC, which then conducts its own evaluation and ruling.

Although the CMA takes charge more often than not the UK’s takeover process will ultimately remain under the jurisdiction of the EU, at least until the outcomes of Brexit are known. This is important because an increasing amount of M&A deals in the UK are cross-border, with foreign firms buying UK ones and vice-versa.

There has been growing concern about the amount of UK firms being bought by foreign companies, with some believing the government and regulators should have tighter restrictions to stop British business falling into foreign hands.

There has been little reason for the UK or the EU to be concerned about cross-border M&A and instead scrutiny has been on examining buyers from the likes of China and, to a lesser degree, the US. But post-Brexit, depending on the relationship, we could see M&A between the UK and the EU become harder if they look to protect their businesses from one another. Equally, breaking free from EU law could open up a smoother process for deals to be struck with both UK firms and those outside the EU.