Acquiring listed funds - What's new?

By Jacqueline Christie.

Key Points:
A further round of consolidation in infrastructure and real estate funds may be imminent and there are several options for structuring these transactions.

A value gap between underlying assets and trading prices is currently endemic in infrastructure and real estate funds and may make the funds attractive takeover targets. In addition, many funds may be forced to seek a structural solution when faced with the difficulty of raising money and refinancing debt during the global credit crisis. These factors indicate that a further round of consolidation in infrastructure and real estate funds may be imminent.

The steep decline in asset and unit values has also provided a focus for increasing scrutiny of management lock-ups as investors realise that entrenched management arrangements can potentially frustrate a fund's attempt to respond to potential acquirers and to the broader financial crisis.

We discuss below some emerging issues for M&A activity in this sector.

Know your management agreements

Until recently most funds included a description of the key terms of their management agreement in their PDS, but did not release the full text. The PDS level of disclosure may be sufficient for retail investors, but is generally not sufficient for a potential acquirer trying to ascertain the extent of the legal rights and liabilities flowing from the management agreement upon acquisition of the fund.

On 29 August 2008, ASX issued Guidance Note 26 to attempt to address this issue. The Guidance Note sets out 3 key principles:

• listed entities should retain flexibility to enter into agreements that they feel are appropriate and beneficial
• investors should receive quality disclosure about management agreements so that they make informed decisions on the basis of that disclosure; and
• shareholder approval should be required for material changes to a management agreement.

While the Guidance Note requires that investors receive quality disclosure about management agreements, it does not mandate detailed disclosure or release of the full agreements. ASX does set out the key items which should be disclosed, and these items include the duration of the agreement and termination rights for the listed entity.

In response, both Macquarie and Challenger have released the full text of their management agreements for certain infrastructure funds. Macquarie also amended some of the terms of their agreements, specifically around appointment of directors to fund boards. Babcock has amended some of the terms of its management agreements but is yet to provide enhanced disclosure of the agreements or the full text of the agreements.

Full disclosure of management agreements is welcomed for the greater clarity and transparency such disclosure provides. However, full disclosure does not alter the fundamental terms of a management agreement or water down any impediments to control transactions within it. If the ASX Guidance note encourages greater disclosure, at least potential acquirers will know the extent of the management rights they are dealing with.

Selling off the management

Babcock & Brown Communities (BBC) recently brokered a novel approach to its management agreement. In August 2008, BBC announced the outcomes of a strategic review which yielded two alternatives - internalisation of the management agreement with an associated debt reduction program or sale of the management agreement together with the whole of BBC. At the same time Babcock & Brown Limited (BNB), the manager of BBC, announced its willingness to sell the management rights to either BBC or a third party and confirmed its asking price of $17.5 million.

On 1 October 2008, Lend Lease announced that it had agreed to a series of transactions with BBC including acquisition of BNB's 12.5 percent stake in BBC, taking an equity placement from BBC at a price significantly above BBC's recent trading price and acquisition of the management rights for $17.5 million. With the support of the BBC independent directors, the transaction will be put to shareholders in December.

In this case BNB's co-operation in putting the management rights up for sale facilitated the strategic transaction which BBC required. For any other acquirers or managers contemplating a similar move, the hardest part may be valuing the management rights in the current economic climate.

Buying back the fund

Where a long-term management agreement is in place for an undervalued fund, the manager of the fund, or a related party of the manager, may be in the best position to acquire the fund - we may therefore see a number of privatisations of satellite funds.

Actual and perceived conflicts of interest must be carefully managed when an entity seeks to privatise a satellite fund. ASIC Commissioner Belinda Gibson stated in an August 2008 speech that ASIC will be "looking closely" at these transactions and focusing, in particular, on:

• how conflicts of interest are handled - providing arm's-length valuations and independent experts' reports as to value will be of great assistance; and
• information being provided in a readily accessible form, with frank disclosure about the alternatives to the proposed transaction and the possible benefits of the transaction to the entity proposing it.

The recent acquisition of Macquarie Capital Alliance Group (MCAG) by Macquarie Advanced Investment Group (MAIG) (a private equity consortium led by Macquarie) is an interesting case study. MAIG's acquisition, implemented as a scheme of arrangement, included many positive features for the non-aligned securityholders:

• the independent directors of MCAG had a right to withdraw their recommendation if their fiduciary duties required it (in addition to the standard rights to withdraw if there is a superior proposal or an adverse finding from the independent expert)
• an independent expert's report was obtained regarding whether the offer was fair and reasonable and in the best interests of non-aligned securityholders
• in addition, an independent expert's report was obtained regarding whether certain ancillary arrangements with Macquarie entities were on arm's-length, commercial terms
• voting exclusions for all Macquarie-related entities
• instead of a break fee of a fixed amount, MAIG could receive a "reimbursement fee" of actual costs incurred (up to a cap), payable in the usual circumstances and also where the independent directors changed their recommendation relying on the fiduciary carve out; and
• securityholders were offered cash or "stub equity" in MAIG. The stub equity securities would be unlisted but would allow investors to continue their exposure to MCAG (the stub equity was however subject to a 5 percent minimum and a 20 percent maximum participation, and ultimately was not taken up).

De-listing the fund

Where the value gap between the underlying assets and trading prices cannot be bridged, de-listing the fund may be an alternative.

On 24 October 2008, the unitholders of Everest Babcock & Brown Alternative Investment Fund (EBI) voted overwhelmingly in favour of a proposal to de-list EBI and to introduce unitholder redemption facilities referenced to NTA per unit. Whilst the initial 10 percent withdrawal offer will be at a 7.5 percent discount to NTA, this is still a significant premium to recent trading prices. The next withdrawal offer will be made on 31 December 2009, again at a 7.5 percent discount. Thereafter semi-annual withdrawal offers will be at NTA less transaction costs. Unitholders may also request an in-specie distribution of their share of the underlying assets and liabilities of EBI and, subject to the consent of a third party swap provider, those assets and liabilities will then be rolled into a separately managed account for that unitholder.

Streamlining the process

Finally, we note that new law reform proposals promise to simplify the process of restructuring listed funds and stapled entities.

Although not originally designed for control transactions, a section 411 scheme of arrangement is a well established method of effecting a control transaction for a company. Implementing a section 411 scheme involves an application requesting the Court to convene a scheme meeting, approval at the scheme meeting by a 75 percent majority of the votes cast and by a 50 percent majority in number of members and final endorsement of the scheme by the Court.

Whilst the Chapter 6 takeovers provisions apply equally to companies and trusts, section 411 does not apply to trusts and there is no equivalent regime. Trust advisers have, however, developed a process for effecting a "trust scheme" in a way which is superficially similar to a section 411 scheme. Implementing a trust scheme essentially involves a general meeting where the target members must approve an amendment to the trust's constitution to allow implementation of the scheme (a 75 percent majority is required) and separately approve the acquisition of target units under s 611 item 7 (a 50 percent majority is required). The target trustee may also seek judicial advice under the Trustee Act to attempt to replicate the section 411 court process.

Takeovers Panel Guidance Note 15 states that a trust scheme is an acceptable alternative to a takeover bid provided that the policies and protections afforded to unitholders under Chapter 6 are complied with.

The disparity between the company procedure and trust procedure is confusing and the situation gets more complicated in the case of a stapled structure. Even though all the shareholders in a stapled security are the same as the unitholders, a stapled security scheme requires the stapled entity to navigate through both regimes and requires at least three separate votes on what is, for all practical purposes, a single transaction.

However, there may be light at the end of the tunnel. The Corporations And Markets Advisory Committee (CAMAC) (the Government's corporate law thinktank) has come up with a proposal to bring listed funds under section 411. Tucked away in the back of its recent Discussion Paper on section 411, CAMAC canvasses this possibility and notes that it would have many advantages:

"Extension of the scheme provisions to listed management schemes may facilitate the rationalisation and redesign of complex corporate/fund structures through one process. It may also better protect the interests of unitholders or other beneficiaries, including through ASIC involvement and court review of the proposed scheme."

Even if the advantages are somewhat overstated, the CAMAC proposal is welcome. It would be useful for stand-alone listed trusts as it would provide a formal statutory structure for trust schemes rather than the ad hoc system we currently have. And it would certainly assist stapled security structures as acquisitions of such entities could be implemented by a scheme of arrangement under a single regime.

For further information, please contact Jacqueline Christie.