Is two better than one? A look at dual scheme of arrangement and takeover bid structures

Dual structures back in the spotlight 7 min read

The recent contest for control of Nitro Software Limited – between Potentia Capital and KKR-backed Alludo – has thrust the strategy of concurrent scheme of arrangement and 'fall back' takeover bid structures back into the spotlight.

In this Insight, we break down the structures – examining what they are, where they've been used and why – and outline some central considerations for bidders, target boards and target shareholders.

What are they and why are they used?

Dual structures were developed to enhance contestability in public M&A auctions in circumstances where a so-called 'blocking stake' is held by a major shareholder (who is often one of the competing bidders) – typically, a shareholding of circa 20%, which may take the form of a physical holding or an interest in the target company via an equity derivative instrument. Based on historical voter turnout, such a shareholding is usually sufficient to effectively vote down a scheme of arrangement (given that the primary approval threshold at a scheme vote requires at least 75% of votes cast in favour).

A pre-bid stake may also be combined with other deal-protection mechanisms for the shareholder/bidder, such as a public statement that the bidder will not vote in favour of any rival scheme or accept any rival takeover bid (even if it is at a higher price to its own bid). Under ASIC's 'truth in takeovers policy', the shareholder would be bound to follow through with such a statement. Given bidders for ASX-listed companies (particularly PE bidders) typically seek to acquire 100% control through a scheme, a material pre-bid stake combined with an undertaking to oppose any rival transaction significantly limits a target company's ability to run an effective auction process, particularly when faced with an offer that is considered opportunistic by the target company board.

In very simple terms, a dual structure typically works like this: where Bidder 1 holds a blocking stake and makes an offer at price X, Bidder 2 enters into an implementation agreement with the target company, which agrees to propose a scheme at price Y for a 100% acquisition (at a premium to price X), coupled with a commitment from Bidder 2 to make a concurrent off-market takeover bid (with a lower minimum acceptance threshold, typically 50.1%) at price Z (often a slight discount to the scheme price, reflecting (among other things) that the bid may not deliver outright ownership and in order to provide an incentive to target company shareholders to vote in favour of the scheme). The scheme booklet, bidder's statement and target's statement are combined in a single 'transaction booklet' and the takeover bid is made conditional on the scheme not proceeding (ie the scheme vote failing) and remains open for acceptance after the scheme vote. While Bidder 1's blocking stake may be able to defeat the scheme, it is insufficient to prevent a controlling interest passing to Bidder 2 under the takeover bid (although, in practice, the pre-bid stake will make it more challenging for Bidder 2 to satisfy the 50.1% minimum acceptance condition).

Where and how have they been used in practice?

First implemented by Brookfield in Prime Infrastructure and then more notably in 2019 to navigate a rival private equity-led consortium's toe-hold interest in Healthscope, variations of the dual structure playbook were subsequently adopted by BGH Capital in Village Roadshow, JBS in Huon Aquaculture, CapVest in Virtus Health and Alludo in Nitro Software. 

The majority of these dual structures have been effective – the primary schemes in each of Healthscope, Village and Huon were successful (for differing reasons, noting none ultimately faced a binding competing bid).  However, the Virtus scheme was abandoned by CapVest before being put to a shareholder vote (in the face of a superior and effectively unconditional counter-bid from BGH Capital, which held a circa 20%+ stake that it had promised to vote against the CapVest deal at any price) and the Nitro Software scheme proposed by Alludo was, in a first for dual structures, actually voted down by shareholders (led by competing bidder Potentia, which similarly held a circa 20% stake).

Blessed by regulators

Notably, the validity of dual structures was considered recently by the Takeovers Panel in Nitro Software, where the sitting Panel confirmed that, while more complex than single transaction structures, it did not consider the structure to be unacceptable. In fact, the sitting Panel went so far as to say, 'the availability of the dual scheme/bid structure in this case was pro-competitive as it likely enabled a competitive auction for the benefit of Nitro shareholders notwithstanding Potentia's pre-bid stake'. The decision was reviewed, with the review Panel on Friday affirming the decision of the initial Panel not to make a declaration of unacceptable circumstances (noting its reasons are yet to be published). 

As part of the Nitro proceedings in Nitro Software, ASIC also confirmed that the Corporations Act does not prohibit dual structures, although noted the structures are 'a relatively untested and new emergence' that it considers on a case-by-case basis.

While dual structures have not been expressly challenged before the courts, each of the integrated transaction booklets considered by the courts in the deals above were approved at the first court hearing, and each of those schemes that have been put to, and passed by, shareholders have in turn been approved by the courts at the second court hearing.

Dual structures do, however, present an interesting intersection between the respective jurisdictions of the Takeovers Panel (takeover bids) and the courts (schemes). Indeed, both bodies have acknowledged the complications a challenge before the Panel (eg with respect to disclosures in the transaction booklet) could present to a concurrent scheme approval process before the courts, and suggested further ASIC guidance could be helpful. This also goes to the broader question of whether jurisdiction over schemes should instead sit with the Takeovers Panel, which was considered by the Government last year as part of a consultation process. For more on this, see our Insight: Should the Takeovers Panel have jurisdiction over schemes?, noting that the Government has since confirmed that it will not proceed in pursuing these changes to the takeovers regime.

Considerations for target boards

Faced with a blocking stake held by a bidder (or dissenting shareholder) and a commitment to vote that stake against a rival bid, a dual structure proposal from the rival bidder is an effective alternative for a target board to consider in seeking to promote a competitive auction.

Invariably, however, dual structures do raise layered considerations for target boards in deciding whether to proceed with such a proposal. The target board will need to carefully consider whether the dual structure is in the best interests of shareholders, including the potential for minority shareholders to retain their shareholding in a quasi-privatised target should the scheme fail and the takeover proceed. The target board will also need to consider whether (and when) to recommend that shareholders vote in favour of the scheme and in turn accept the fallback bid, particularly given a shareholder who accepts a bid is not ordinarily entitled to withdraw that acceptance should a superior alternative be tabled. To the extent a board is minded to recommend shareholders accept the fallback bid at the same time as voting in favour of the scheme (ie before knowing whether the scheme is successful), its reasons for making the recommendation together with the opportunity cost of this decision should be expressly disclosed in the transaction booklet (as the Panel found that Nitro Software did in relation to its recommendation to shareholders).

Considerations for bidders

Although not unique to dual structures, bidders should pause to consider the practical reality of a fallback bid, which should not be viewed only as a theoretical downside scenario. In particular, unlike a scheme which delivers 'all or nothing' ownership, if the concurrent takeover bid has a 50.1% minimum acceptance condition, the bidder will need to be comfortable that, if the scheme fails, it may remain a controlling but not outright owner of a listed company limited by minority shareholder considerations (unless the bidder's interest reaches at least 90% under the bid to permit compulsory acquisition of the shares held by remaining shareholders).

Most immediately, this has implications for acquisition financing (which, if available in this structure, is typically more expensive), including the ability to tax efficiently refinance the target debt. In addition, going forward, the bidder will have to manage a likely unsupportive minority shareholding base (which may well include the underbidder or dissenting shareholder). For example, absent securing >75% control, a bidder may not be able to unilaterally pass special resolutions, which are necessary to (among other things) delist the target and approve selective distributions and financial assistance to the bidder.

Dual structures are also likely to have implications for the underbidder holding the pre-bid stake in circumstances where the fallback takeover bid is successful. Particularly in relation to PE bidders, in a situation where another party (often a rival PE bidder) acquires control of the target company but less than 100%, the underbidder will need to turn its mind to how it will ultimately be able to exit its own investment in the target company.

Where to from here?

Dual structures remain a higher risk strategy given they can result in suboptimal outcomes, but their successful execution in some examples means they will continue to be adopted and have a place in the takeover toolkit absent a change of regulatory or judicial direction. With competition for increasingly scarce quality listed targets set to remain high—particularly among cashed up private capital sponsors—look for variations of these assertive structures to be used more regularly and more creatively.