Rise of the bear hug buyout

Despite the return of public M&A activity to the Australian market last financial year, there is growing evidence that bidders remain cautious in their approach to launching deals and are reluctant to go live without knowing that the target board is behind the deal.

Bidders are taking this approach for varying reasons, but our research has shown that in the current market doing a hostile deal is more risky and less likely to be successful. According to the Freehills second annual Public Mergers & Acquisitions Report, the success rate of hostile deals in FY2010 was only 30 per cent, compared to around 70 per cent for friendly deals in the same period.

Another reason for the dominance of friendly deals may be that bidders are becoming increasingly comfortable with the scheme of arrangement structure, which requires target board cooperation.

Schemes are especially favoured when the stakes are high. Nearly all of the high end deals ($1 billion or more) in Australia last year were structured as schemes. The fact that scheme timetables are gradually getting quicker as advisers develop strategies for minimising procedural delays, may also be playing a part in their rising popularity.

That is not to say that bidders aren't being aggressive in their approach. Increasingly we are seeing deals where the bidders are still seeking target board support, but are not waiting until that support is secured before seeing the deal announced to the market.

This "bear hug" strategy is often used in an effort to garner shareholder support which translates into pressure on the target board to facilitate the deal. But recent statistics show this strategy does not have a great success rate – only one deal out of the 14 which used a similar approach in FY2010 was successful.

However, the fact that the use of bear hugs is on the rise (they were not used at all in Australian M&A deals in FY2009) shows that bidders are looking for means of pushing forward with deals without completely throwing caution to the wind.

Once past the initial hurdle of securing target board approval, bidders naturally continue to try and secure their deals with favourable "lock-up arrangements” with the target. These include matching rights and break fees with 85 per cent of negotiated deals in FY2010 having some form of "no-shop” arrangement and 80 per cent involved a break fee payable by the target.

While BHP Billiton's recent tilt at PotashCorporation is a notable exception, in the current market it seems unlikely that bidders will shrug off this guarded approach and get back to launching hostile raids on unsuspecting targets.

It is not just Australian politics that is having to come to terms with a new, "friendlier” paradigm. But although the bidders' caution is likely to continue in the coming period, we can rest assured that bidders, like the politicians, are working hard on new and creative ways of throwing their weight around in a friendlier M&A environment.

Simon Reed is a Corporate M&A partner at Freehills and is the author of the Freehills 2010 Public Mergers & Acquisitions Report.