ASIC released a consultation paper in June 2019 regarding the use of stub equity in public to private transactions, essentially looking to clamp down on the types of bid vehicles that could be used and seeking to eliminate the use of trustee / custodian structures so that Chapter 6 of the Corporations Act would apply after the conclusion of the bid.
After receiving a variety of submissions, ASIC has now come out with its final position on the use and regulation of such schemes.
ASIC's initial proposals
In June 2019, ASIC proposed two major reforms for stub equity scrip offers in public to private transactions.
First, that certain disclosure exemptions would not apply to offers of securities in proprietary companies, such that stub equity scrip offers could not be made using a proprietary company.
Second, that Chapter 6 of the Corporations Act would essentially have mandatory application to the bid vehicle, even if the bid vehicle had less than 50 members due to the use of mandatory custodian arrangements.
ASIC reaches a landing
So, where did ASIC land after receiving submissions from the market?
Form of vehicle
As expected, ASIC has prohibited stub equity scrip offers being made by proprietary companies. Stub equity scrip offers can, however, still be made by public companies (including unlisted public companies).
This is a sensible compromise, in our view, given the real danger of ASIC's initial proposed reform driving PE sponsors to use offshore incorporated vehicles (a clearly retrograde outcome for Australian shareholders). Examples do already exist for unlisted public company stub equity vehicles being used on public to private transactions (such as Brookfield's privatisation of Healthscope and PEP's recently announced privatisation of the Citadel Group).
Use of custodians
ASIC has decided to permit the continued use of mandatory custodian arrangements, provided those arrangements include 'conversion and termination provisions'. The provisions must operate on the basis that if, post implementation of the transaction, the public company stub vehicle seeks to convert to a proprietary company when it has more than 50 non-employee beneficial owners, the custodian arrangement must terminate, and all beneficial owners must be registered as members. Chapter 6 of the Corporations Act would then apply if there were more than 50 members. The 'conversion and termination provisions' can only be modified by a special resolution of the beneficial owners who are subject to the mandatory custodian arrangement.
Additional ASIC guidance
ASIC has also stated that it will be "better practice" for:
- the independent expert report to include a valuation and opinion on the stub equity scrip offer;
- target directors to include a recommendation on the stub equity scrip offer; and
- both of the above positions to be clearly and prominently disclosed in the scheme booklet.
It will be interesting to see how the market responds to these "better practice" positions. To date, very few independent expert reports in stub equity public to private transactions have looked to formally assess the underlying value of any stub equity offered. One such example was TPG's privatisation of Greencross Limited. In that transaction the independent expert formed the view that a combined marketability and minority discount of between 30% to 35% should be applied to the value of the stub equity scrip offer (as compared to the all-cash offer). PE sponsors should be prepared for independent experts asking more questions on their stub equity holding vehicles, the capital structures being used and the finances of those vehicles.
To date, target directors have not customarily sought to give a recommendation on the stub equity component(s) of any offer. A recent example does exist where directors have come out and expressly not recommended such an offer (Brookfield's privatisation of Healthscope Limited), although that is a relatively recent phenomenon. It is again going to raise some interesting questions for target directors about how much information they will need from PE sponsors to provide an informed view on any stub equity offered. No doubt the independent expert's view on the value of the stub equity will be a major influence for that recommendation.
KWM's overall assessment
Based on ASIC's original reform proposals, the reforms strike a far more balanced position than was first feared.
Requiring the use of public companies (instead of proprietary companies) as stub equity vehicles is a manageable outcome, in our view. PE sponsors will of course need to be mindful of the additional regulation that applies to public companies, but none of that should prove insurmountable in practice.
The ability to continue to use mandatory custodian arrangements as part of any offer will mean that the number of shareholders in a stub vehicle will stay sensibly sized and the post transaction structure can stay out of the Chapter 6 takeover rules. Most importantly, the shareholder agreement terms will remain paramount. Disclosure around shareholder agreement terms in the relevant scheme or takeover documentation will need to be suitably fulsome to ensure that target shareholders have an opportunity to understand fully what they will be agreeing if they accept a stub equity offer (we expect ASIC to keep an eye on this in the future). The rules that apply on conversion or termination of the stub equity vehicle are sensible and should again not lead to any problems in practice.
Finally, the so called "better practice" recommendations from ASIC will likely mean more interaction between independent experts and PE sponsors as the expert embarks on a value assessment of any stub equity being offered. That should be manageable, in our view, but will likely take some time for experts to work out how deeply they need to dive on the stub equity vehicle to form a view. Be prepared for more negative recommendations from directors and more time being spent on the expert value discovery process, albeit we don't currently see either aspect radically extending the length of the transaction process or leading to any materially greater or lesser uptake of stub offers by shareholders (which currently sits at a very low 1%).