Public-to-private deals present a target for arbitrage funds

The latest economic forecast from the International Monetary Fund paints a bleak picture for the G7. UK output is expected to grow by just 0.4% this year, one of the worst outlooks in the group. France and Italy fare slightly better at 0.8% and 1.1% respectively. Even the U.S. is on course for just 1.8% expansion.

Germany, the poorest performer, is predicted to go into recession. This follows three relatively lean years by international standards; in 2021, most G7 nations benefited from a post-pandemic rebound of more than 4%, and in some cases close to 7%. Germany’s economy grew by less than 3%.

The reasons for Germany’s struggles are manifold. Its economy is founded on industrial manufacturing and particularly conventional vehicles, where its national champions have been overtaken in the shift to electrification.

German companies rely heavily on exports to China at a time when East/West tensions are strained. It also has some of the highest electricity costs in the world, the legacy of years of poorly designed energy policy, an overreliance on Russian gas and a deficit of sites capable of supporting large-scale renewable power generation.

The German government is implementing a strategy to decarbonise its economy by becoming a hydrogen importer, but the benefits will not be felt for years. In the meantime, its energy costs are set to remain high with the transition funded through taxation.

As more take-private deals kick off, expect a rise in activist investment

Despite these challenges, German corporates invest heavily in R&D and are renowned for their good governance. Against this backdrop, investment bankers are starting to see more take-private processes kicking off as financial investors and corporates explore opportunities to buy fundamentally sound companies at a discount.

History suggests this will spark more activist activity, with funds building stakes in the wake of rumoured bids or announced offers in order to:

• intervene during the acceptance period to force up the offer price; or
• take action post-closing to block the integration of the target and initiate proceedings aimed at forcing the bidder to acquire the remaining outstanding shares for a higher price than the initial offer price.

This type of activism has been on the rise, including in 2021/22 when Petrus, Teleios Capital and others intervened to block a sponsor-led takeover of Aareal Bank, with the bidders eventually returning with a higher offer that was accepted. 

And recently, following a takeover bid for leading real estate company Deutsche Wohnen SE by its competitor Vonovia, we saw Elliott Management (through its investment vehicle Cornwall) claiming for a special audit of the actions of the target’s management over accusations they breached their duties. The respective shareholder resolution proposal was voted down, but it remains to be seen whether a court will order the audit to go ahead.

Some features of the German regulatory framework making it a prime market for arbitrage funds. For any bidder considering an investment in Germany, there are some nuances to consider.

Investing in Germany: issues to consider

• Hostile takeovers are not common in Germany but they do happen. However, any German public company facing a hostile bid only has a limited array of takeover defences to work with.
• After a bidder has published its decision to launch an offer, the target’s management board cannot intervene to prevent it except in limited circumstances. These include actions that a prudent and conscientious manager would have taken absent a bid; the search for a “white knight”; actions approved by the supervisory board; or actions authorised by shareholder resolution.
• If these conditions are satisfied, the management board can implement a handful of defensive measures, all of which are tightly controlled under German takeover law. They are, in particular: issuing new shares from authorised capital; executing a buyback of treasury shares to increase the voting power of friendly shareholders and reduce the free float available for purchase; disposing of treasury shares to an anchor shareholder; or disposing of material assets.
• The fact these defences are relatively weak means target boards more often focus on whether they can create more value on their own than with the bidder, with synergies a hot topic in many takeover negotiations.. 
• That said, hostile bidders also face obstacles, including that they are limited to basing their bid on publicly available information (eg annual accounts, articles of association, register of major shareholders), even where they are competing with a recommended offer. There is no provision in German law that grants a hostile bidder access to the same information as a recommended rival, but the target’s management board will need to decide whether the denial of due diligence would constitute a breach of its duties.
• As far as M&A activism is concerned, under German law, investors holding a single share have the power to initiate judicial proceedings following a bid to increase the compensation due under common post-closing integration measures, such as domination and profit and loss transfer agreements and squeeze outs (whereby a majority shareholder seeks to force those with minority stakes to sell up).
• These proceedings may last for years, and data shows that as a consequence of specific German valuation regimes applied by the courts, the compensation offered it often raised significantly. In this scenario all minorities have to be paid the additional amount, even those who didn’t initiate the proceedings.
• Holding 1% of the nominal share capital (or shares with a nominal value of EUR100,000 or more) enables a shareholder to apply to bring a derivative lawsuit against members of the management board and supervisory board to seek compensation for perceived losses in a deal, and to apply for the appointment of a special auditor to test whether assets have been undervalued.
• Shareholders with 5% of the nominal share capital plus one share can block a squeeze out unless the majority shareholder pursuing the merger holds 90% or more of the shares. Investors with 10% of the nominal share capital plus one share can therefore block any attempt to force a squeeze out.

Not every public offer attracts event-driven activists. But where they are present in the target’s stock, the bidder will need to execute a carefully crafted legal and comms strategy to get the deal over the line.