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23 January 2019
One of the highest profile public M&A transactions of 2018 was the competitive takeover battle between Comcast and Fox for the control of Sky, against the backdrop of Disney's proposed merger with Fox. This article on the transaction looks at the application of the chain principle.
As Disney was proposing to merge with Fox and one of Fox's assets was a 39% stake in Sky (which is subject to the Takeover Code), the Takeover Panel Executive had to consider:
The ruling on price was particularly significant to Sky and its larger shareholders given the competing bids from Comcast and Fox to acquire Sky and the impact that the panel's decision regarding Disney could have had on the outcome of the competitive process.
The Takeover Code is founded on six general principles, the first of which states that:
all holders of the securities of an offeree company of the same class must be afforded equivalent treatment; moreover, if a person acquires control of a company, the other holders of securities must be protected.
The code gives effect to this principle by requiring a person that acquires a controlling interest – broadly, for code purposes, 30% or more of the voting rights – in a company to which the code applies to make an offer to the other shareholders in that company to purchase their shares.
The price at which a mandatory offer must be made (or if already made, increased) must be:
The rationale behind the mandatory offer rule is to:
In order to prevent a party circumventing the mandatory offer requirement through an indirect acquisition of control, the code extends the mandatory offer obligation to situations where a first company (Company A) acquires more than 50% of a second company (Company B, which need not be a company to which the code applies) and, as a result, acquires or consolidates control of a third company to which the code applies (Company C).
Although the Takeover Panel Executive should be consulted in each case which may fall within the above fact pattern, it will not normally require a mandatory offer to be made unless:
The code does not set out how to determine the offer price that Company A must offer to Company C shareholders in circumstances where the chain principle requires a mandatory offer to be made.
In December 2017 Disney announced that it had entered into a merger agreement to acquire Fox for approximately $28 per share. At the time of the announcement, Fox held a 39% stake in Sky (a company subject to the code) and had announced a firm intention to offer for the remaining 61% at a price of £10.75 per Sky share.
Applying the chain principle described above, in April 2018 the Takeover Panel Executive announced that it had informed Disney, Fox and Sky that within 28 days of the completion of its acquisition of Fox, Disney would be required to make a chain principle offer for Sky at a price of £10.75 per Sky share. The basis for the ruling was the executive's view that securing control of Sky might reasonably be a significant purpose of Disney acquiring control of Fox.
In June 2018 Comcast made an all-cash proposal to acquire Fox at a price of $35 per Fox share, and, in response to this superior proposal, Disney announced an increase in its own offer for Fox to approximately $38 per share, with the option for Fox shareholders to elect for cash or stock subject to a 50/50 pro-rating. In July 2018 Fox announced an increase in its offer for Sky from £10.75 to £14 per Sky share.
On 13 July 2018 the executive announced that as a result of Disney's increased offer for Fox, Disney's chain principle offer price for Sky would be increased to £14 per Sky share. This ruling was challenged by the Sky Independent Committee and several of Sky's larger shareholders, which asked the Takeover Panel Hearings Committee to review the decision. On 3 August 2018 the hearings committee confirmed the executive's ruling and on 15 August 2018, following a further appeal, the Takeover Appeal Board confirmed the hearings committee's confirmation of the executive's ruling.
As noted above, the code does not provide a mechanism for calculating a chain principle offer price. Therefore, it was open to the Takeover Panel Executive to determine how best to do this, particularly given that there was no appropriate precedent to follow – none of the small number of prior cases had involved, among other things, Company B (Fox) having substantial assets other than its stake in Company C (Sky) and Company C being the subject of competing offers.
First chain principle offer price of £10.75
To determine the first chain principle price following Disney's initial offer for Fox, the Takeover Panel Executive first approached Disney and Fox to see if they had attributed a value to Fox's stake in Sky when negotiating the acquisition. Fox stated that it had made clear in negotiations that the price for the stake in Sky was £10.75 per Sky share, while Disney disclosed that it had included a price of £10.75 in an investor presentation. Although Disney claimed that this value had been included only because it was an externally verifiable valuation of the asset for investors to use and that it had actually valued the stake at below £9 per share, its inclusion was evidence that both parties had attributed a value of £10.75 per share to Fox's 39% stake in Sky.
The executive then examined the valuation materials prepared by and for Disney (including fairness opinions) to see if they supported this price. In particular, the executive looked at three discounted cash flow (DCF) valuation ranges of Fox prepared by Disney's advisers (which valued Fox without any synergies, with cost synergies only and then with both cost and revenue synergies, and which assumed Fox's offer for Sky did not complete), which showed the proportion of this value represented by Fox's 39% stake in Sky. The executive considered a DCF analysis the most appropriate tool as it was better able to capture the evolving nature of an asset than a valuation based on a multiple of earnings before interest, tax, depreciation and amortisation.
In the DCF valuations shared with the executive, because Disney took the view that no synergies could be gained from 39% ownership of a publicly listed company, bringing into account anticipated synergies added value to Fox's other assets and increased the value of those assets relative to the value of its stake in Sky. Accordingly, the percentage contribution of Fox's stake in Sky was highest on a no synergies basis and lowest on a basis that accounted for both cost and revenue synergies. Here, the executive's approach was to take a mid-point valuation to test the £10.75 per share data point against (the rationale being that the prospect of deriving synergies almost always has some impact on the acquisition price and that the DCF valuation which accounted for cost synergies could be used as a rough proxy for this). This mid-point projection indicated that the stake in Sky represented 18% of the DCF valuation of all Fox's relevant assets which, when applied to the total consideration payable and then divided by the number of Fox's shares in Sky, produced a price per share of £10.53.
As this figure from Disney's advisers (and the figure that Disney itself had produced, which was even lower) did not exceed the price of £10.75 that had been publicly attributed by Disney to Fox's stake in Sky, the executive concluded that a first mandatory offer price of £10.75 was appropriate to offer to all Sky shareholders.
Second chain principle offer price of £14
To determine the second chain principle offer price, following Disney's increased offer for Fox, the Takeover Panel adopted the same approach as before (ie, it identified a data point which most effectively pointed to the price per share to be paid by Disney for Fox's stake in Sky and tested this against the parties' internal valuation materials). This determination was set against new evidence that Disney was intent on acquiring 100% of Sky following the emergence of Comcast's competing offer for Sky and that the 39% stake could be viewed as a springboard for consolidating control.
In this instance, although Disney had not published an attributed revised value to Fox's stake in Sky in its investor presentation materials, shortly following the increase in its offer for Fox, it had authorised and supported an increase by Fox in Fox's offer for Sky to £14. It was this authorisation and support (which included agreeing to take on the increased debt which Fox would have to incur to make the higher offer) that the executive considered to be "compelling evidence of an agreed attribution of value by Disney" for Fox's stake in Sky against which they could again test the valuation materials prepared by and for Disney.
As before, the executive tested the £14 data point against the DCF projections of the relative value of the stake in Sky and the other assets of Fox. In light of these valuations and having considered certain adjustments on the basis of representations made by Disney that expected synergies would flow from Fox's US assets and not Sky, the executive concluded that a chain principle offer price of £14 per share was generous and certainly not too low.
Linear increase point
A linear approach to determining the second chain principle offer price (ie, to increase the mandatory offer for Sky by the same proportion as Disney had for Fox) was promoted by Sky and some of its shareholders. However, this approach was ruled out by the Takeover Panel Hearings Committee on the basis that:
Differences in the form of consideration offered under the first and second offers for Fox and movements in Disney's share price, as well as disagreements over what the correct starting point for any linear increase calculation should be, further complicated the calculation.
True and fair value point
One Sky shareholder, Elliott Advisors (UK) Limited, challenged the Takeover Panel Executive's approach to price on the grounds that it was too dependent on material prepared by parties which had a strong interest in valuing so as to minimise the chain principle offer price. It was contended that only a determination of the true value of Fox's stake in Sky relative to the totality of Fox's relevant assets could provide fairness to other shareholders in Sky, and that such an assessment of value could be made only by an independent expert.
In rejecting this argument, the Takeover Panel Hearings Committee noted that that chain principle offer price should give effect to the mandatory offer rules and related principles, which oblige the party in question to offer to other shareholders the highest price actually paid, not a price which represents the true or fair value of the company's shares at a given time. The object is to secure equivalent treatment (not a generalised concept of fair treatment) by ensuring that the price paid to obtain or consolidate control is offered to all offeree shareholders, who can then choose whether to accept it. Therefore, an assessment of the fair, true or reasonable value of Fox's stake in Sky was an incorrect approach to determine the chain principle offer price.
Further, it was stressed that the executive's scrutiny of Disney's and Fox's materials was detailed and conducted with appropriate rigour. The executive had not just accepted the parties' say on price, but had also determined objectively against the available data what price was actually to be paid by Disney for Fox's stake in Sky.
The Takeover Panel Executive will assess a chain principle offer price on a case-by-case basis. It will look to see whether any price for Company C was agreed between Companies A and B in their negotiations or whether there is any other evidence or data indicating an agreement on the price. It will then work backwards from this point and objectively examine the parties' valuation materials in order to test whether the price attributed by Companies A and B is reasonable in light of the overall value of Company B's assets (given the obvious limitation that any approach which allows parties to self-certify could be abused by ascribing artificially low values to Company C).
The chain principle offer price should attempt to reflect the highest price paid by Company A for Company B's controlling interest in C, not some fair or true value of the stake in Company C assessed at any particular time. The objective is to ensure that whatever price was received by the shareholders of Company B for their shares in Company C will be offered by Company A to Company C's other shareholders, which can then choose whether to accept it.
For further information on this topic please contact Will Pearce or Joseph Scrace at Davis Polk & Wardwell London LLP by telephone (+44 20 7418 1300) or email (firstname.lastname@example.org or email@example.com). The Davis Polk & Wardwell website can be accessed at www.davispolk.com.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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