Game of chicken

In March, Blackstone's €3.1bn landmark public-to-private of German chemicals group Celanese almost hit a wall when hedge funds refused to tender their shares. PEI's Deal Mechanic explains why

The Blackstone Group's €3.1 billion buyout of Celanese is one that the industry will remember. The largest ever German public-to-private; the largest LBO of a pure German company; the first tender offer for a joint US-German listed entity to be completed since new German securities laws were enacted two years ago – the list of differentiators is impressive.

Still, equally significant is the fact that Celanese was also a deal that very nearly didn't happen. The reason for that warrants closer examination.

When Blackstone's tender offer, launched in December at €32.50 per share (13 percent above the average share price of the preceding 90 days), entered the decisive stage, Celanese's shareholders fell broadly into three camps: the Kuwait Petroleum Company (KPC) with an ownership stake of 29 percent; other long-term shareholders, including large institutional players such as Fidelity and First Pacific, accounting approximately for a further 30 percent; and finally a variety of hedge funds. It is the presence of the latter group and the tactics they employed that are worthy of further analysis.

When the new German securities laws came into force in 2002, they were hailed as being fairer to shareholders than the ones they replaced. It was predicted that shareholders would be more confident about the process, and ultimate outcome, of a tender offer. Bidders, equally, would be able to work with a set of rules that would establish a clearer framework and give them a definite timetable to work to.

These expectations have largely been met, but what Celanese has shown is that in practice some of the details do not quite work. And details are what hedge funds understand well. In this case, the details that mattered were in the rules that govern public tender offers in Germany.

TWO THRESHOLDS
Under the takeover rules of most markets, there are two levels of share ownership to be achieved that are relevant to bidders. The first is required to establish “domination”, or effective operational control over a target. In Germany, as in many other jurisdictions, that level is set at 75 percent.

The second is the level at which socalled “squeeze-out” provisions can be enforced – 95 percent in the case of Celanese's Frankfurt-listed shares. This is the threshold at which court proceedings can be set in train which force the remaining minority shareholders to sell their stakes, albeit at a price that is typically determined by the legal process: an independent valuer sets the price in accordance with a valuation procedure based on a complex and somewhat arcane formula proscribed in law. To date, most practitioners have simply looked at precedent when attempting to predict the level at which this price will be set: sometimes it can be higher than the offer price, at other times it is lower.

For a private equity bidder and its financial backers, domination, though important, is usually not enough: only full control will prevent cash leakage, i.e. the loss of cash flow in the form of dividends paid to minorities when cash is transferred from the operating companies to the holding entities, where the acquisition debt is usually located. This is why equity sponsors in public-to-private transactions typically push for the minimum level of acceptances to be set at a very high level for the transaction to proceed.

In the case of Celanese, the initial threshold was set at 85 percent. As one party close to the transaction described it, this was an “economic play”: although 75 percent would have been sufficient to achieve operational control, getting to 85 percent would have meant that Blackstone would need to acquire just 15 percent of the company's outstanding shares at a potentially higher price.

That was the plan. What happened in practice though turned out not to be quite so controlled.

DEAL DATA

Target Celanese
Country Germany
Industry Chemicals
Sponsor The Blackstone Group
Acquisition date April 2004
Target value €3.1 billion ($3.68 billion; including pension liabilities of
1 billion)
Acquisition financing €690 million equity; €540 million funded senior debt;
€400 million revolver (unfunded); €1,640 million bridge
financing
Transaction price 7.7X original 2003
EBITDA estimate (numbers subsequently revised when
results announced, but this was basis of offer doc so is
probably most relevant)
Total debt 4.3X original 2003 EBITDA est