Bidvest’s 60% offer suggests backroom negotiating Adcock shareholders want to be in pharma

THE takeover battle between Bidvest and Adcock Ingram is turning into a ding-dong affair, and like many tough takeover battles, it is exposing an interesting and important part of takeover law.

Just to recap a bit, here is what has happened so far.

Bidvest, the widely diversified industrial group, sent Adcock, a pharmaceutical provider, a takeover proposal to acquire 60% of the company. For the acquisitive Bidvest, this is hardly an unusual process; it’s known in the market as the Joffe bear hug, Brian Joffe being Bidvest’s much admired — and feared — CEO.

For Adcock, the proposal theoretically came as a surprise.

It’s a real eye-opener to track the share prices of the various companies in the healthcare sector: it’s not just that Adcock has trailed. It’s that almost all the others have exploded except for Adcock.

Adcock’s two closest rivals, the much smaller Cipla and the much larger Aspen, are up 70% and 173% on a three-year frame, compared with Adcock’s 3.5%. In that context, it’s surprising that anyone would be surprised at a takeover bid, especially since Cipla is also a takeover candidate at the moment.

In any event, the proposal entails a R6.2bn takeover bid, pegged at R62.82 a share, an 11% premium, half in cash and half in Bidvest shares.

The Adcock board response was unusual: it argued essentially that it did not believe that a firm intention of offer had been made, because the legal requirements of a firm intention had not been met.

This opens up a wonderful new can of worms. Firm acceptance or firm rejection are pretty well-known tracks, but to claim neutrality on the bid while rejecting it on legal grounds, is a bit of novelty. Hence, the pertinent question now becomes, are these claims valid?

From talking to some lawyers and takeover experts, the consensus seems to be pretty sceptical. But this is an untested area so, in all honesty, who knows?

The issue, in legal terms, is what one lawyer described as a “slippery” definition in the new Companies Act about what constitutes a “valid and binding offer”.

Before we get there, however, it is worth noting that much of the press has suggested that Bidvest might go, or has gone, hostile. This remains a possibility, but is not my reading of what Bidvest has actually done, so far at least.

If Bidvest had “gone hostile” it would have used the other of the two legal options available to a would-be offeror, and that would be to make a general offer.

Of course, a “general offer” is a simple offer to shareholders to buy their shares at a certain price.

But Bidvest has not gone down that route, or not yet.

Why not? Presumably because one of the great virtues of the “scheme of arrangement” route — the other route available to the would-be offeror — is that it constitutes an agreement, so it can consist of anything the parties want.

This provides the opportunity for conditions, stipulations, price matrices, and crucially, due diligence. But it does require the cooperation of the board.

I suspect what Joffe is most worried about is whether the takeover would trigger any contractual problems with Adcock’s pharmaceutical suppliers. Since, he has also mentioned an earnings assurance connected to a price matrix.

In other words, if the company’s earnings don’t hold up, the offer price gets sliced.

There is one other thing that is interesting here: the offer is for 60% of the shares.

Now I don’t know if this is true or not, but that does not seem Joffe’s style by any means. I would almost guarantee he would want 100%. So why did he settle for 60%?

In public interviews Joffe indicated that shareholders were convinced there was upside in the share price and were keen to remain exposed. I bet what actually happened was a bit different. I bet he spoke to a lot of shareholders who agreed generally that Bidvest should manage the group.

But there was some tough bargaining over the takeover price compared to the target proportion, and eventually the fund managers relented on price and Joffe relented on the takeover proportion.

If I am right, then the Adcock board is in a much tighter position than many suspect. This makes their “go legal route” tactic a bit more explicable, since what they want to avoid is having to put any kind of bid to shareholders. At first, I was a bit confused by this, because the takeover premium is very small, so it would seem much simpler for the Adcock board just to refuse to accept the offer on the basis that it’s stingy — which it is. But obviously the board wanted something more.

So what are these legal objections and will they stand up? I’m not a lawyer, but my instinct is they won’t, or at least, not all but one of them, and the deficiencies of that one are easy to remedy. So the board might find itself cornered.

According to the statement of Dr Khotso Mokhele, chairman of Adcock’s board, Adcock is concerned about “the high level of conditionality, including ‘walk-away’ rights, the absence of comparable offers for two of our other key stakeholders, namely our BEE partners and employees, who are participants in our group share incentive scheme”. The Bidvest letter also fails to address the position of the remaining minority shareholders after such a transaction has taken effect.

The absence of comparable offers for other classes of shareholders can easily be remedied by making them the same offer, which was presumably implied anyway. The “walkaway” rights are essentially conditions that the offeror sets, which allows it to walk away if they are not met. They are a powerful tool in the hands of the offeror because if the company does walk away on the basis that it considers certain conditions have not been met, and that becomes public knowledge, that makes investors assume that certain problems exist. These conditions therefore act as an incentive to agree to takeover terms.

But it depends on what they are. There may be more in this case than meets the eye, but from what has become visible, they don’t seem to be unreasonable, except in one case. What Bidvest wants to know is whether a takeover bid will trigger a renegotiation of contracts and whether earnings are holding up.

The problem area concerns a conditional clause that the successful bidders, Bidvest in other words, can buy a further 15% of the company if shareholders accept the 60% takeover. That seems to suggest an agreement to treat different classes of shareholders differently, which would be illegal.

Still, if Adcock didn’t like this clause, or others, it could have asked for the offer to be remedied. It doesn’t seem that difficult.

Joffe has, if I understand him correctly, suggested a novel approach. What he has argued is that if the board is genuinely neutral about a takeover offer, then why does it not make its objections known, but nevertheless put the offer to shareholders? Even if the board recommends against the bid, they should really let shareholders decide.

Unfortunately for Bidvest, this is more a moral argument than a legal

ONE other thing about the battle is whether Adcock’s shareholders are “stale” or “soft”. The latter notion is related to the decision by Tiger Brands to hive off Adcock in 2008.

The idea is that Adcock inherited a shareholder base that was actually more interested in consumer goods than the pharmaceutical industry.

I think that this is unlikely. I’m sure those shareholders would have cycled out by now.

Likewise, even though Adcock’s share price has been static for a long one. For a scheme of arrangement to be put to shareholders, the board’s co-operation is necessary.

Something else is worth remembering. The board not only has a fiduciary duty to shareholders. It also has a duty to act with care and skill. And that is now actionable in terms of the new Companies Act, by minority shareholders.

This battle is not over.

APART from the legal issues, does Bidvest’s bid for Adcock make any sense? From a management viewpoint, it’s hard to be too sympathetic to Jonathan Louw and his team; they have missed out in critical competitions, missed the move to generics, and for a long time opted out of foreign expansion. It rubs salt in the wound that Aspen has managed these things with such aplomb.

But there are some suggestions about a change in the fortunes of the company. The company points out that it won a significant slice of the government’s 2012 antiretroviarals tender, a new product pipeline is good, it has a grand new distribution centre, and it has just made acqui- time, I suspect their current shareholders are not stale and many have sensed a turnaround. Trading volumes were certainly up strongly in January this year.

The biggest problem as regards the shareholder base is that because Adcock is lightly held, there are lots of investors who hold both Adcock and Bidvest.

That’s a big plus for Bidvest, presumably, partly because it is one of the few companies which have grown as fast as the healthcare sector over the past three years. sitions in Ghana and India.

The shift in the tide is presumably one of the things that is attracting in Bidvest — and it’s the reason why shareholders are keen to stay at least partially exposed. The mere fact of a 60% rather than a 100% bid is an implicit acknowledgement by Bidvest that the fortunes of the company seem brighter.

But the main question is about logistics, since this is one of Bidvest’s great strengths. The company’s advocates argue the notion that there is synergistic logic in the merger is faulty. It is, they argue, a bit simplistic and in fact, the logistics of a pharmaceutical company are different from other consumer goods, even fairly complicated goods such as fresh produce. There is a huge security protocol, and temperature is important, among other factors. In fact, one of Adcock’s great strengths is its logistics, they claim.

I’m not sure what to make of this, but I’m sceptical. Even if the types of goods are very different, I just don’t think Bidvest would take very long to catch up. In any event, logistics costs are not a determining part of Adcock’s world. Hitting the right markets is — and that is where the company has been lacking.