OSC should review H&R / Primaris break fee

News report: H&R REIT offers $4.6B in friendly deal for Primaris

If you’re a shareholder, the definition of success in any M&A takeover is simply defined as getting the best possible price for your stock. There are two ways that might come to pass. A friendly deal, where a company puts itself up for sale (what’s usually referred to as kicking off a process to review “strategic alternatives”) for whatever reason and cuts a deal. Or a “hostile” bid situation, where a bidder gets something started and puts the Target’s Board into a forced sale process. Normal course stuff.

The Primaris situation was unique since it pitted one Ontario pension plan (OPB) versus the offspring of a far larger Ontario pension plan (OMERS). There were the usual stirrings about the initial bid undervaluing the target’s assets, and that it was opportunistic from a timing standpoint (pre-holiday season). Of course, there’s nothing unique about that either. Open Text bid for Accelio right before the Christmas season got rolling, and RIM tried a similar angle on Certicom in 2008. The theory being, I suppose, that international bidders will be reticent to pick up their pencils if it means interrupting a ski holiday in the Swiss Alps.

That the Primaris Special Committee was able to recruit a higher offer should come as no surprise. That the format of the H&R REIT offer includes features that are likely auction-ending should be a concern to everyone who owns shares of public companies.

H&R’s bid has a normal 2.6% cash component to its break fee (worth $70 million), which would be paid in the event that Primaris accepted a higher bid from another party. Cash break fees are a normal part of the M&A world. Two percent of the deal, maybe as high as four percent. Any higher than that and the Ontario Securities Commission would say it was abusive. I can’t remember the specific deal where a 5% cash break fee was struck down by the OSC (I’m sure Jeff Lloyd or David Ward do), but there is definitely precedent for the Commission to get involved if they think auction-ending tactics are being employed.

On Primaris/H&R, its the two asset options that upset me. The Primaris Board granted H&R the right to acquire the Dufferin Mall shopping centre and a parcel of land on Yonge Street at a $36 million discount to their appraised value (which when the FMV discount is included with the cash component of the break fee comes in around 3.8% of the equity value of the proposal; nice touch compared to the traditional 4% ceiling). Getting a core asset at a discount as a break fee? It just shouldn’t be legal, even if it supposedly is.

I forget the specific details of the 1998 WIC-Western Radio Station break fee, but this Dufferin Mall concept sounds a lot like that one.

The rights of Directors to enhance shareholder value are very broad. A Court may well uphold the efforts that the Primaris Board went to in an effort to draw in H&R REIT, although the fact pattern of the WIC-Western precedent is sufficiently different that I think the Superior Court could set this deal aside, if asked.

KingSett’s actiities over the past few weeks seem to be textbook to me, including asking the Commission to block the Primaris Rights Plan. According to Primaris, however, they’ve been silent (hat tip CP):

Mr. Morrison was asked if Primaris had gone back to KingSett to get them to up their offer. “At the very beginning of the process there was a reach out to KingSett by our advisors inviting them to come back and speak at any point during the process and to the best of our knowledge they never did,” he said.

The details aren’t public, but I assume KingSett wasn’t given the chance to see the Primaris data room without signing a non-disclosure agreement. Sounds fair enough, unless that NDA required Kingsett to only bid for Primaris provided the Board agreed to accept an acquisition proposal. In essence, having gone hostile, target Boards almost always require the original “hostile” bidder to agree to bow out if so required by the Target’s special committee. Few “hostile” bidders ever find that appealing. The negotiations go something like this.

“Hostile” bidder: if you want us to raise our first offer, you’ve got to give us more information that is currently available in the public domain.

Target: if you want access to the data room, you’ll need to sign the NDA.

“Hostile” bidder: But the NDA stipulates that we are giving up our right to appeal directly to shareholders if you go a different direction.

Target: Yep.

I’ve never thought this chase-your-tail dance served the Target’s shareholders well. And now that Kingsett can’t acquire all of the assets of Primaris, whatever unit price they might bid now, who wins?

For the Ontario Securities Commission, I assume they’ll look at this and point to the WIC-Western decision as the precedent. I’m not sure that’s good enough, for each situation is different. Were the radio assets at play in the WIC-Western Cable deal core to the rationale for bidding? I’d think not. They represented just 0.6% of WIC’s net income.

This is more like a software company granting a perpetual licence to its intellectual property to a White Knight, or Dofasco agreeing that its White Knight had the right to acquire the Iron Ore Company of Canada via an asset option (ore being a key ingredient in Dofasco’s steel operation). Or Disney giving an option on the Mickey Mouse trademark and licence. You need the IP or the ore to produce the asset itself. What’s Disney without Mickey? Is there a better way to foreclose further bids in a M&A deal than granting someone else an option to take the brain out of the body before a new owner shows up? Or, to use a real estate analogy, who wants to buy a house if the renter intentionally introduced termites to the property right before moving out as the new owner takes possession?

I think not, but I’m not a Securities Lawyer. Let’s not confuse an “asset option” with termites. The OSC needs to set some clear parameters around the types of assets options, and the materiality to the overall business, that’ll be permitted. What’s the point of disallowing a 5% cash break fee if other abusive, auction-ending tactics are given the all-clear?

If the OSC ducks, KingSett needs to seek relief from the Courts. WIC’s radio stations don’t match the value of these key Primaris assets to a topping bidder.

MRM
(disclosure — updated 1/28/13 to reflect correct cash break fee calcs)