Focus: CULS – equity financing for conditional acquisitions
26 May 2011
In brief: Recently, Seven West Media Limited partially funded its acquisition of Seven Media Group with an accelerated non-renounceable entitlement offer of Convertible Unsecured Loan Securities to its shareholders. Partner Tom Story (view CV), Senior Associate Bob Speed and Lawyer Alex Borda examine the acquisition and the pros and cons of the use of CULS.*
How does it affect you?
- Convertible unsecured loan securities (CULS) offer an alternative financing technique for listed entities looking to equity finance an acquisition.
- CULS offer two key benefits to the more common issuance of ordinary equity, delivering up-front certainty of funding for the proposed deal and flexibility to easily return the funds raised and maintain the pre-existing capital structure if the deal does not proceed.
Seven West Media (SWM) shareholders who participated in this CULS offer were issued with unsecured loan notes by SWM. The loan notes were automatically converted into ordinary SWM shares on a one-for-one basis following SWM shareholder approval of the Seven Media Group (SMG) acquisition and satisfaction of other conditions precedent. SWM used the money raised to partially fund completion of the acquisition.
If the deal had not gone ahead, the CULS would not have converted and would instead have been redeemed at face value plus a redemption premium (ranging from 2.5 per cent to 4.5 per cent). The CULS had a final maturity date of 30 June 2011, at which time all CULS were required to be redeemed, if not converted or redeemed prior to that date.
It has been some time since the last issue of CULS in Australia. Prior examples include:
- Metcash Trading Limited – in 2005, Metcash undertook a A$746 million rights issue of CULS to fund a capital restructure involving the establishment of a new holding company and the buyout of Metcash's South African-based majority shareholder, Metoz Holdings; and
- ING Industrial Fund – in 2006, ING Industrial Fund undertook a A$300 million non-renounceable entitlement offer of convertible loan securities. The purpose of the offer was to assist in the funding of the formation of a joint venture between ING Industrial Fund and ING Real Estate to make a takeover bid to acquire a REIT listed on TSX.
In the UK, CULS offers are known as 'trombone rights issues'. Past examples include the US$1.4 billion rights issue by Xstrata in 2003 to fund its acquisition of MIM by way of scheme of arrangement. These are now regarded as less attractive in the UK as a result of changes in tax and accounting law1. CULS offers are very common in Canada, where they are known as 'subscription receipts'.
As the CULS were a new class of SWM security, they were required to be offered under a prospectus. The SWM prospectus was a 'transaction specific prospectus' which can be used for the offer of continuously quoted securities. Australian Securities & Investments Commission Class Order 00/195 extends this regime to offers of securities convertible into continuously quoted securities.
As the CULS were quoted on the Australian Securities Exchange (ASX), ASX approval was also required for the CULS terms of issue.
CULS were also unsecured notes for the purposes of Chapter 2L of the Corporations Act 2001 (Cth) , so SWM was required to enter into a trust deed and appoint a trustee in compliance with Chapter 2L.
Possible alternatives and advantages of CULS
With tighter access to debt finance post-GFC, bidders are increasingly looking at options to finance M&A activity through the equity capital markets. There are a number of options other than CULS that may be available in these circumstances.
- Conditional rights issue – One potential approach would be a rights issue of ordinary shares, with settlement conditional on satisfaction of the relevant transaction conditions. This structure may require a longer settlement period, leading to greater underwriting risk, higher fees and worse pricing. If the transaction and the rights issue are conditional on shareholder approval, ASX Listing Rule 7.15 will require the record date for the rights issue to be at least seven days after the shareholder meeting. This means that shares would trade with entitlement up until that date and would effectively require the offer period to extend well past the meeting. Accelerated institutional offers would also be problematic in light of this rule.
- Front-end unconditional capital raising (including traditional and 'low-doc' rights issues, placement or share purchase plan) – The key problem with this approach is over-capitalisation of the company if the transaction does not proceed and the potential requirement to return funds via a capital reduction or selective share buy-back, each of which require shareholder approval.
- Back-end rights issue – Another option would be to delay the capital raising until after all relevant transaction conditions (or at least the key conditions) are satisfied. This approach may be effective, depending on market conditions and shareholders' reaction to the proposed transaction. The company will be exposed to potential funding risk, such that if market conditions tighten or investors react negatively to the proposed transaction or the overhang, the company may struggle to raise funds or be forced to offer a materially larger discount than originally envisaged.
Against the above alternatives, CULS offer two key advantages for a party financing an acquisition that is subject to conditions (in particular a requirement for shareholder approval) that can make a successful outcome uncertain:
- certainty – issuing CULS delivers equity funding certainty by locking in funds necessary to complete the proposed transaction at pre-announcement pricing. It also permits an accelerated settlement timetable, which reduces the period of risk exposure for underwriters; and
- flexibility – if the proposed transaction is not successful, CULS are redeemed, enabling the company to return the funds raised easily and maintain the pre-existing capital structure.
Drawbacks to CULS
There are a number of potential drawbacks to CULS that need to be considered.
- When compared to the common traditional or 'low-doc' rights issue structures, CULS offers are relatively rare and there is a lack of retail investor understanding and awareness in relation to their use.
- If the relevant transaction does not proceed, the company will bear the cost of the underwriting fees and funding the payment of the redemption premium to shareholders. However, these costs may be partly offset by interest earned on the funds prior to redemption, and are similar to costs borne for other financing alternatives, for example, commitment fees or costs of establishing an equity bridge facility if using debt finance to fund the acquisition.
- The requirement to prepare a prospectus means that the company, directors, underwriters and various advisers may have potential civil and criminal liability in Australia for the prospectus which they would not otherwise bear under a 'low-doc' right issue regime. On the other hand, the statutory due diligence and reasonable reliance defences are available with a prospectus.
- There are other risks specific to CULS that need to be clearly identified in the prospectus, for example:
- time/delay – if transaction conditions take a long time to satisfy, CULS holders may be left holding them for longer than expected. This risk may be mitigated through an attractive and/or scaled redemption premium and a fixed maturity date, which provide a certain end date and return on capital for CULS holders; and
- CULS are unsecured, so CULS holders are subject to (pre-acquisition) credit risk on the issuer. Depending on the existing level and type of debt in the issuer, consideration may need to be given to incorporating some protections for CULS investors into the CULS terms, such as an issuer negative pledge or an escrow arrangement for the proceeds of issue.
* Allens provided legal advice to Seven West Media (formerly known as West Australian Newspapers Holdings Limited) in relation to its acquisition of Seven Media Group.
- Tom StoryPartner,
Ph: +61 2 9230 4812
- Jon WebsterPartner,
Ph: +61 3 9613 8832
- Andrew PascoePartner,
Ph: +61 8 9488 3741
- Chelsey DrakePartner,
Ph: +61 7 3334 3202
- David WengerPartner,
Ph: +852 2903 6256
Ph: +976 7711 0231