Use of stub equity in control transactions

By Guy Alexander, Noah Obradovic, Chris Blane, Charles Ashton
Mergers & Acquisitions Private Equity

ASIC's long-awaited response 4 min read

ASIC has released its response to the submissions on its June 2019 Consultation Paper on certain aspects of the use of stub equity in control transactions, and the news is mostly positive.

A recap

Stub equity schemes involve the bidder, in addition to offering the standard cash consideration, offering scrip consideration in the form of shares in the bid vehicle (or, more typically, the holding company of the bid vehicle, the Holdco). This provides an opportunity for target shareholders to retain an economic exposure to the underlying business of the target company, through holding scrip in the Holdco. Stub equity alternative consideration has been offered in many bids by private equity over the last few years, but that had largely dried up following ASIC's objections to aspects of the structure.

ASIC's two concerns

As covered in our June 2019 Insight, ASIC's Consultation Paper identified two separate concerns in relation to the structure:

  1. Where an Australian proprietary company, rather than an Australian public company, was used as the Holdco vehicle. ASIC's very strong view is that the Corporations Act contains a number of disclosure and governance protections for shareholders in public companies, and if a bidder can use a proprietary company to make a broad-based offer to target shareholders, including retail shareholders, the intention of the legislation would be defeated.
  2. Where all target shareholders who elect to receive the stub equity alternative are required to hold their shares in the Holdco through a single custodian, who is the registered holder of all such shares. The purpose of this structure is to ensure that the number of registered shareholders in the Holdco stays below 50, so that the takeover provisions and the unlisted disclosing entity provisions of the Corporations Act do not apply to the Holdco going forward. This facilitates the operation of the Holdco and the future exit.

The outcome of the consultation is mostly positive

ASIC has maintained its position on the first point (so no offering of shares in an Australian proprietary company), but, following our submissions and those of other respondents on the consultation paper, it has relented on the second (so custodian structures are ok). The ASIC response noted that to ban the use of custodian structures may simply force bidders to use foreign entities rather than an Australian entity as the Holdco, which would result in even less protection for retail shareholders, or may result in retail shareholders simply not being offered the opportunity to participate.

ASIC's response is a sensible one, and should facilitate the continued use of stub equity going forward. Having to use an Australian public company as the Holdco (assuming an Australian company is used) should not prove too great an obstacle. Yes, the Corporations Act restrictions that apply to public companies (eg the related party transactions provisions, and the provisions prohibiting conflicted directors voting at board meetings) will apply, but the shareholders deed for the Holdco offering stub equity will often contain analogous provisions in any event.  

Disclosure issues – a slight sting in the tail?

All that said, there is a slight sting in the tail in the ASIC response paper. In schemes which include stub equity consideration, it is usually the case that:

  • the directors' recommendation that shareholders vote in favour of the scheme is based on the cash consideration only, and the directors make no recommendation in relation to the stub equity scrip consideration; and
  • the independent expert's opinion that the scheme is fair and reasonable and in the best interests of target shareholders is based on the cash consideration only. The report usually makes it clear that if the expert had given their opinion on a transaction involving the scrip consideration only, they would have concluded that the deal was not fair.

In the response paper, ASIC states that the fact that the directors are not making a recommendation in relation to the stub equity alternative is often not prominently disclosed in the scheme booklet, and that the absence of a recommendation makes it difficult for target shareholders (particularly retail shareholders) to decide between the cash and scrip consideration. ASIC also has concerns that the limitation on the independent expert's opinion is often not prominently disclosed, and that the expert does not provide any valuation and opinion on the scrip alternative.

ASIC therefore considers it would be 'better practice' for:

  • the directors to include a recommendation on the scrip consideration;
  • the expert to include a valuation and opinion on the scrip; and
  • both points above to be clearly disclosed in the scheme booklet.

This is likely to lead to some heated discussions during ASIC's review of the scheme booklet on transactions in the future. Where the expert has given a valuation of the stub equity scrip in the past, it usually involved the application of a 30% discount to the value of the target shares, to reflect the terms of the stub equity scrip and the lack of liquidity in the unlisted Holdco shares compared to the target. It may be that experts are to be forced down this route again. For target boards, we think there will be reluctance to include a recommendation on the scrip consideration, given the nuances of the scrip alternative and the fact that the scrip may be attractive to some target shareholders, but not others.