In takeovers, minority investors are often treated like the slaves of their acquiring masters. Not in Germany. M&A rules in Europe’s biggest economy, centred on ominously-named domination agreements, indeed feature a strong hint of masochism. But as Austrian chipmaker AMS may soon discover in its €4.5 billion quest to snare Munich-based Osram Licht, its normally the bidder which ends up enduring the pain.
In the more M&A-friendly United Kingdom, buyers that own more than half of a target’s shares can dictate strategy, control cash-flows and use a so-called scheme of arrangement to squeeze out minority shareholders with minimal fuss. In Germany, everything is a bit more complicated.
The set-up works like this. A purchaser needs 50 per cent of a company’s shares to force changes to its supervisory board and influence strategy. But to control a target’s cash-flows, as financial buyers usually require, an owner must secure 75 per cent of votes at an extraordinary general meeting in support of a domination agreement. The remaining minority shareholders then surrender their voting rights to give the acquirer outright control.
The ‘safe word’
In return, the newly gagged minorities get the option to sell their shares for a fair amount, to be determined by independent assessors and the courts. Until that day comes, they collect an annual payment that is supposed to replace the dividends they aren’t getting in the meantime.
The upshot of all this is a dynamic worthy of the protagonists in the bestselling erotic novel Fifty Shades of Grey , with controlling financier Christian Grey and submissive college graduate Anastasia Steele playing the parts of buyer and minority shareholders, respectively. The domination agreement means the acquirer gets to do what it wants with the powerless company. But investors get protection akin to Anastasia’s safe word which, when uttered, requires her to be untied. Everyone’s happy.
Except they aren’t. Relatively low turnouts at German shareholder meetings mean domination agreements are normally approved with far less than 75 per cent of the company’s shares. For instance, if investors representing just 70 per cent of the shares turn up, a predator with a 53 per cent stake can get over the line. Furthermore, there is ample scope for companies and investors to argue about price, mainly because the external valuation is based on discounted cash-flow analysis. Courts can only permit increases in assessed valuation, not reductions. And the annual dividend, also determined by the external assessors but generally 5 per cent, is not only high but guaranteed. With no time limit to legal proceedings, sharp-eyed hedge funds that spy a looming domination agreement can make easy money.
Osram scenario
Here’s how it could work with Osram. A hedge fund might amass a 10 per cent stake, worth 363 million euros at AMS’ €41 per share offer. With its 5 per cent annual payout and a guaranteed floor price for the shares locked in, the fund could borrow 90 per cent of its total outlay. Assume it pays 2.5 per cent a year in interest, uses the remaining dividends to pay off the loan, and eventually gets 10 per cent more for its AMS shares than it paid for them. After seven years, the fund will have quadrupled its money before legal fees, according to a Breakingviews calculation, at an internal rate of return of 26 per cent.
Such fat rewards make would-be predators like AMS look more like submissive Anastasia than domineering Christian. Britain’s Vodafone is a particular glutton for German punishment. The mobile phone giant’s legal battle to squeeze out minority shareholders following its €190 billion takeover of Mannesmann in 2000 lasted 18 years. Its 2013 acquisition of Kabel Deutschland, of which hedge fund Elliott Management owned more than 13 per cent, is still dragging on. In the meantime, the liability on Vodafone’s books to buy out Kabel Deutschland’s minority shareholders has risen from £1.3 billion in 2013, then worth around €1.53 billion to €1.84 billion this year.
This explains why buyers pondering bids for German companies are keen to carve out safe words of their own. They are pleading with domestic regulators and politicians to reduce the dividend minority shareholders can expect. Slashing it closer to bank financing rates would mess up the hedge funds gearing games. Senior German bankers told Breakingviews that some companies are even registering themselves in neighbouring Luxembourg, where a less lopsided takeover code makes them more attractive to prospective suitors.
However, one big stakeholder seems perfectly comfortable with the status quo : the government in Berlin. According to two frustrated German bankers, national suspicion of overseas takeovers gives politicians little reason to heed the calls for change. Yet, without reform, every domestic company will be subject to a domination discount. And sub-par executives and companies will have less to fear from takeovers, blunting corporate Germany’s international competitiveness. In other words, trying to identify sadists and masochists in Germany’s M&A dungeon is a waste of time. Everyone is both.
(The authors are Ed Cropley and George Hay, BreakingViews columnists.)