Public to private pitfalls

What is your take on recent developments at Debenhams?
It is interesting to contrast events at Debenhams with other equivalent recent situations. Often the independent directors and their advisers are at pains to prevent a situation developing where there is a perception, warranted or not, of de facto exclusivity at an early stage in the process. Clearly, publicity so early on is also unwelcome. However, the practicalities of carrying out the levels of due diligence required for a public to private mean that maintaining confidentiality is exceptionally difficult. Having said that, we do not know the full factual background to the Debenhams situation, and it certainly appears that there is some non-public history to this.

Are institutional shareholders justified in crying foul in scenarios such as the Debenhams bid?
Stock market values are driven in considerable measure by the sentiment of institutional shareholders. They are placing a lower value on the prospects of some companies than the value placed on them by the private equity community. Private equity sponsors, in conjunction with banks and the capital markets, are prepared to pay institutional shareholders cash now for what they consider to be the true value of the business. If shareholders think that this undervalues the company, they can buy stock, raise the price and defeat the approach. If that does not happen, shareholders also have the right to accept or decline any offer made. However, a situation where shareholders may see themselves as having no alternative to accepting an offer is certainly unattractive from a shareholder perspective.

How does the Takeover Code deal with these kinds of transactions?
The Code offers a reasonable number of protections. A committee of independent directors of the Board must be formed once management has declared an interest. That committee must have independent financial advice. Equality of information must apply as between all competing genuine offerors. Management's business plan as made available to financial backers must be made available on request to the independent directors – any hidden nuggets should then be available to them before a recommendation is made.

The terms on which management's existing equity in the target is to be rolled over into equity of the offeror must be approved by the independent financial adviser as being fair and reasonable. If management hold a stake of more than 5 per cent in the target company which is to be rolled-over, then an independent shareholder vote is also required.

Have there been relevant changes to it?
The Panel took a great step forward in facilitating public to private transactions some years ago by amending the Takeover Code to allow targets to agree break-up fees capped at 1 per cent of the offer value, subject always to legal constraints and the Panel's prior approval. What this meant was that the very considerable costs in terms of due diligence, documentation and bank commitment fees could be covered if for example a third party offeror was successful. These arrangements are now pretty common in public to private transactions.

Is the Code adequate?
Generally, yes. However, the value of the protections will always depend on the situation and personalities involved. On occasions, the independent directors could do a better job of making sure that the offer that gets recommended is the best reasonably obtainable for shareholders, irrespective of whether it is necessarily the best offer for management. If a change to the Code is called for, it would be to defer management's ability to negotiate equity terms with potential financial backers until after offer terms have been agreed with the independent directors. Any change would have to be flexible enough to deal with a wide variety of situations.

How should non-executives manage incumbent management involved in a private equity-backed P2P?
Too much suspicion and a lack of understanding of the process can deprive shareholders of a valuable cash offer. But clarity is important. Process letters from the independent directors setting out clearance procedures and the role of management in assisting third party offerors are a helpful development and are to be welcomed. And there is room for improvement. For example, independent directors could push for equity in the bidding vehicle to be made available to shareholders, although this would not suit many institutional shareholders who can only hold listed investments.

Are private equity firms guilty of getting too close to management too soon?
Private equity firms have a duty to their investors to do the best transaction that they can. If the constraints placed on management do not preclude open access to potential offerors, then it is unsurprising that private equity firms will maximise their advantage.