One of the most high profile bid situations during 2018 involved the competitive offers for Sky by 21 Century Fox and Comcast. For a public process that started in December 2016 and was not concluded until October 2018, it is perhaps not surprising that the transaction saw many different facets of the rules of the Takeover Code come into focus. One of the more obscure provisions of Rule 9 in particular, the so-called "Chain Principle", attracted particular attention and resulted in a series of appeals to both the Panel's Hearings Committee and thereafter to the Takeover Appeal Board against rulings made by the Panel Executive. Bird & Bird acted as secretary to the Takeover Appeal Board on these appeals.
In this note, we take a brief look at the background to the appeals, how the Chain Principle operates and the reasons for the Panel Executive's rulings being upheld on appeal.
Rule 9 of the Code seeks to protect shareholders of Code-regulated target companies in circumstances where a person (or group of persons acting in concert) either acquire a controlling shareholding (which for Code purposes comprises a shareholding of 30% or more) or consolidate control by acquiring further shares (i.e. where a holding of more than 30% but less than 50% is already held). Any such acquisition of control or consolidation of control will normally require a mandatory offer to be made for all other shares in the relevant Code company (often referred to as a Rule 9 Offer). Where a mandatory bid obligation arises, the party incurring the obligation will generally be required to offer to acquire the remaining shares at the highest price paid by the acquirer of shares in the company during the 12 months immediately preceding the mandatory bid obligation arising. And in order to ensure there are minimal impediments to a target company's shareholders being able to sell their shares into a mandatory offer, such offers can generally not be subject to any conditions other than a condition that the acquirer achieves a level of acceptances of the offer which takes its aggregate shareholding to majority control (i.e. 50% plus one share).
The "Chain Principle" is enshrined in note 8 on Rule 9 of the Code. It recognises that in certain circumstances, a person (or group of persons acting in concert) who acquires a controlling interest in one company, which need not itself be a company to which the Code applies, (Company A) could thereby acquire or consolidate "Code Control" of another company to which the Code does apply (Company B). This could arise where Company A itself owns a 30%+ shareholding in Company B.
The Sky bid situation was classic chain principle territory. Sky had originally been formed out of British Sky Broadcasting and at the time of its flotation, 21 Century Fox retained a minority shareholding of 39%. When 21 Century Fox first announced its interest in making an offer for Sky in December 2016, this took the form of a conventional voluntary offer, where the company's largest existing shareholder was seeking to make an offer to all other shareholders so as to acquire full control. 21 Century Fox had not made any acquisition of shares at that time and, as such, there was no requirement to make any mandatory offer. Had the transaction played out without interruption, it would have been for the independent board of Sky to have made its recommendation on the terms of 21 Century Fox's voluntary offer and independent Sky shareholders would have decided whether or not to sell in the normal course.
Application of the Chain Principle
The Chain Principle became potentially relevant in December 2017 when 21 Century Fox and Disney announced that they had separately agreed terms for a proposed acquisition of 21 Century Fox by Disney for a cash consideration of $28 per 21 Century Fox share. On completion of that transaction, Disney would acquire a controlling interest in 21 Century Fox (not itself a company to which the Code applies but Company A, in chain-principle-speak). In doing so it would also acquire 21 Century Fox's existing 39% interest in Sky (Company B and a company to which the Code does apply). The Panel therefore had to consider whether the Chain Principle should apply such that there should be a requirement on Disney to make a mandatory Rule 9 offer to all other Sky shareholders in the event that its acquisition of 21 Century Fox proceeded to completion.
It is worth noting that note 8 on Rule 9 makes it clear that a mandatory offer will not always be required in such circumstances. In particular, the Panel will not normally require a mandatory offer to be made unless either (i) the interest in shares in Company B is significant when compared with the other assets of Company A (with relative values of 50% or more are usually regarded as significant) or (ii) securing control of Company B might reasonably be considered to be a significant purpose of acquiring Company A. In the Sky bid situation, even though 21 Century Fox had significant other media assets aside from its interest in shares in Sky, the Panel concluded that acquiring a controlling interest in Sky could reasonably be said to be a significant purpose of acquiring 21 Century Fox. Disney initially refuted this conclusion, but ultimately did not appeal the Panel's decision that the Chain Principle should apply and there is little doubt in hindsight that Sky was viewed as being the "jewel in the crown" of 21 Century Fox.
Having announced on 17 December 2017 that in view of the proposed acquisition of 21 Century Fox by Disney, it was considering the potential application of the Chain Principle to the Sky bid situation, the Panel then announced on 12 April 2018 its ruling that the Chain Principle would apply and that the price at which a mandatory offer would need to be made (should the acquisition of 21 Century Fox by Disney go through) would be £10.75 per Sky share. This price was equal to the price per share offered by 21 Century Fox in its already announced offer for Sky. The Panel's ruling on this was made following detailed submissions from a variety of interested parties and although not all parties agreed with the conclusions reached by the Panel, the ruling was accepted by the primary parties to the bid situation (being 21 Century Fox, Disney and Sky).
Comcast's intervention and the Panel Appeals
Things became more interesting in April 2018 when Disney's rival, Comcast, announced a firm intention to make an offer for Sky at £12.50 per share. Like 21 Century Fox's offer, the Comcast offer was a pre-conditional offer as it was subject to certain regulatory approvals. To complicate things further, Comcast also announced that it would be interested in acquiring 21 Century Fox on the same terms as Disney, but for a higher cash price of $35 per share. This prompted 21 Century Fox and Disney to renegotiate the terms for its deal so as to eclipse the price offered by Comcast. As Disney was now potentially paying $38 per share to acquire 21 Century Fox as opposed to the originally agreed $28 per share, it followed that the value ascribed to 21 Century Fox's shares in Sky (and therefore the price that would apply on any Chain Principle offer) had to be re-evaluated by the Panel. On 28 June 2018, the Panel confirmed that it was considering this point in light of submissions received by a number of interested parties.
Before the Panel made any ruling on the appropriate revised Chain Principle Offer price, 21 Century Fox announced an increased offer for Sky at £14.00 per share. This offer was made with the support of Disney which not only consented to the making of the increased offer but also committed to reimburse 21 Century Fox in respect of a proportion of the additional consideration offered in the event that the Disney/21 Century Fox deal did not complete in certain circumstances.
This was then eclipsed by a further increased offer by Comcast for Sky at £14.75 per share. Comcast had by this stage withdrawn from its interest in acquiring 21 Century Fox to focus its efforts solely on acquiring Sky.
It was against this background that the Panel announced its ruling that, as a result of the revised terms agreed for the acquisition of 21 Century Fox by Disney, the revised price at which Disney should be obliged to make a mandatory offer for Sky (should its acquisition of 21 Century Fox proceed to completion) should be £14.00 per Sky share. Sky notified the Panel Executive that it intended to request a review of this ruling by the Panel's Hearings Committee and in that context, the Panel invited any other interested party who wished to make submissions to the Hearings Committee on the matter to do so.
A number of interested parties took part in the hearing before the Panel Hearings Committee including the Panel Executive, Disney, 21 Century Fox, Sky and a number of Sky shareholders, primarily hedge funds. The Hearings Committee upheld the Panel Executive's decision on the Chain Principle price and as a result there was a further appeal to the Takeover Appeal Board. The appeal to the Takeover Appeal Board was, in essence, a re-hearing of the Hearings Committee decision with all of the original parties involved as well as the Panel Executive and members of the Takeover Appeal Board. Ultimately, the original decision of the Panel Executive was upheld.
The arguments made on appeal and the reasons for the Panel's ruling
As things transpired, the application of the Chain Principle and the Chain Principle price determined by the Panel did not come into play as the competing bids for Sky were resolved through an auction process at the end of the Code timetable, with Comcast's highest bid of £17.38 per Sky share ultimately prevailing. However, the case undoubtedly sets a precedent for how future assessments of the price that should apply in any Chain Principle situation and therefore there are important lessons to be learnt, not least given that none of the participants in the appeals believed that the Panel Executive had reached the correct conclusion on the appropriate Chain Principle price. As well as initially contending that the Chain Principle should not apply at all, Disney was of the view that the actual value it attributed to 21 Century Fox's shareholding in Sky was significantly below the £10.75 and £14.00 per share prices determined by the Panel Executive, but Disney was content to accept the Panel Executive's ruling on this out of pragmatism, even though it disagreed with the methodology.
There were two fundamental points of principle that led to the Panel Executive's methodology on determining the Chain Principle price being upheld on appeal. The first was that the core principle underpinning Rule 9 (and note 8 on Rule 9) is not that there should be fair treatment of minority shareholders in Sky but rather that they should be treated equally. A number of appellants sought to argue that the Panel's guiding objective should be to determine what would be a fair price in the circumstances. Certain appellants argued that with this in mind, the Panel ought to have instructed an independent expert to ascertain what the fair price would have been. The Panel (and the Takeover Appeal Board, on appeal) rejected these arguments because the Panel is not (and has never concerned itself with) whether or not a particular offer price is fair insofar as target shareholders are concerned. That is for target shareholders to decide based on the independent rule 3 advice that is provided to the target board. There is nothing in Rule 9 (or Note 8 on Rule 9) which contemplates assessing fairness of the price, nor is there any framework for enlisting the view of an independent expert (whose assessment would, by definition, be open to debate). All the Panel is concerned with is seeking to establish what value was actually attributed to the Sky stake by Disney and then seeking to ensure that in any Chain Principle Offer, an equivalent price is offered to all other Sky shareholders.
It is notable that on each determination of a Chain Principle price (the original £10.75 per share ruling and the subsequent £14.00 per share ruling), the Panel reached a conclusion that reflected the live offers on the table at the time. Perhaps not surprisingly, certain of the Appellants sought to argue that the Panel was too quick to accept these figures as determining factors, suggesting that Disney was in effect "self-certifying" what the price it attributed to Sky was. However, it was clear from the evidence put forward in submissions that the Panel Executive was far from purely accepting of facts and information put forward to them by parties who could be said to have a vested interest in particular outcomes. In its original determination that £10.75 was the correct chain principle price, the Panel Executive rejected the Disney argument that the correct price was the lower price shown in its own DCF valuations and instead sought establish evidence that was put forward as part of Disney's process in agreeing a deal with 21 Century Fox. It was factually the case that at that time, the 21 Century Fox offer of £10.75 per share for Sky was in the public domain and that was the price used in public filings by Disney and in its institutional presentations as reflecting the value attributed to the interest in Sky. The Panel Executive was able to demonstrate to the satisfaction of the Hearings Committee (and the Takeover Appeal Board, on appeal) that it had adopted all appropriate and sufficient rigour in testing the arguments of the different parties before forming its conclusion.
One of the other arguments put forward by appellants was that, in relation to the Panel's determination of the £14.00 per share price, a "linear" approach should have been adopted whereby the initial £10.75 price should be taken as the starting point and then the price increased by the percentage by which Disney's acquisition cost of 21 Century Fox increased. The Panel Executive rejected this argument on the basis that it could only be reliable as a methodology if the value of the Sky shares increase precisely in line with the value of all of the other assets of 21 Century Fox. One would also have to be sure of comparing like with like which the Panel Executive was not convinced by. It also pre-supposed that £10.75 was the "right" starting point when both Disney and 21 Century Fox maintained that the figure should actually be lower (even though they had accepted the original Panel ruling out of pragmatism).
This brings us to the second fundamental point of principle. All of the various arguments put forward by the various parties had merits of one sort or another, but by definition all parties had a particular vested interest in the outcome. As no rule book can accommodate every eventuality, there will always be instances where some-one has to determine how a particular situation should be resolved. Ultimately, the Panel Executive's role is to interpret and apply the rules of the Code in an independent manner and exercise its discretions with sufficient rigour and in a manner befitting of the relevant regulator. Note 8 on Rule 9 does not include any specific guidance on the manner in which any Chain Principle price should be determined. Indeed it is notable that, as part of its ongoing review process, in 2008 the Code Committee consulted on whether or not Note 8 on Rule 9 should be amended to introduce set formulae for calculating the appropriate rule 9 price in the context of a Chain Principle offer. It concluded that it should not do so, because each individual case would need to be assessed on its merits. This was never so true as in the Sky case where there were so many complicating factors that would have made a simple formula unworkable. These factors included that 21 Century Fox had a large selection of other assets that would have to have appropriate valuations attributed to them, that certain assets were being spun off at differing values and that the consideration Disney was paying for 21 Century Fox in its revised deal comprised a mixture of cash and Disney stock, again with fluctuating values. In such a complex environment and where there is no prescribed methodology for determining the relevant price, it is entirely appropriate that an independent regulator, well-versed in the manner in which takeovers are conducted and with a capacity to assess the merits of arguments put forward by different interested parties, should be the party to determine what the appropriate price should be. Indeed this is what the Code contemplates.
So having concluded that determining the right Chain Principle Price was all about establishing the value attributed to the Sky shareholding by Disney and that other Sky shareholders should receive equivalent value, and having acknowledged that the Panel can be the only arbiter in applying its rules on this (particularly where no specific formula is prescribed), it was of little surprise that the Panel Executive decision was ultimately upheld.
There has only been six Chain Principle offers required by the Panel in the last 30 years (including the Sky transaction) and so this point does not come up frequently. In that context, it will be interesting to see whether the Code Committee of the Panel takes it upon itself to consider amendments to the Code, particularly in light of scrutiny it came under during the Sky bid.