This past weekend, we witnessed the end of a protracted bidding war for one of the premier telecommunications companies in the UK – Sky plc. Sky is a provider of internet and pay television broadcasting services including news, movies, sports, and pay-per-view events. The fight to acquire the company is one of the more interesting merger situations in which we have been involved lately, and it concluded with a rather uncommon mandatory auction process in the UK.

UK takeover code is unique in that strict requirements are outlined which can dictate the timeline of a deal and the actions of an acquirer. Our team in London has decades of combined experience in UK and European markets, putting us in a strong position to understand the intricacies of this jurisdiction. For example, if a person or group acquires more than 30% of the voting interest of a company, they must make a cash offer to all other shareholders at the highest price paid in the 12 months before the offer was announced. The “Put Up or Shut Up” rule, which was designed to prevent UK companies from facing the prolonged threat of a hostile takeover, can require a company to make a binding offer within 28 days, or be forced to walk away for six months. UK-based deals go “riskless” in their final weeks once certain closing conditions are met, as the acquirer is then legally bound to complete the transaction. Yet another interesting component of UK takeover code is the auction process that is enacted in a competitive bidding situation, which was triggered in the battle for Sky.

Background

The saga began in December 2016 when Fox – the US-based television and film company, which already owned 39% of Sky – offered to acquire the remaining 61% of the company for $23 billion. (Notably, this was not Rupert Murdoch’s first attempt to acquire Sky. Six years prior, News Corp – of which Fox was a part at the time – abandoned a bid for Sky amidst a phone-hacking scandal at one of its UK-based newspaper holdings, which made the deal politically untenable.)

In December 2017, while Fox’s acquisition of Sky was still undergoing regulatory review, Fox entered into a definitive agreement to sell its entertainment assets – including its existing Sky stake – to Disney for $52 billion. This eventually led to two separate bidding wars involving Comcast. First, Comcast made a rival offer for Sky (at £12.50 per share, 16% above Fox’s bid) in February 2018. Second, Comcast challenged Disney with a topping bid for Fox, offering $65 billion in June 2018.

In July, several developments unfolded. On July 11, Fox (with permission from Disney) raised its offer for Sky from £10.75 to £14 per share – only to be outbid by Comcast yet again, which offered £14.75 per share later that same day. Later that month, on July 19, Comcast abandoned its pursuit of Fox in order to focus its efforts on Sky, after Disney increased its offer to $71.3 billion.

The Auction

Since neither Fox’s nor Comcast’s offer for Sky were deemed “best and final,” a competitive situation as defined in the UK takeover code continued to exist. In situations like this and in order to provide an orderly framework, the UK takeover panel conducts an auction process with the relevant parties in which both parties are able to provide their best and final offers for the company. The UK takeover panel and the parties agreed to hold an auction process on September 22, consisting of a maximum of three rounds. In the first round, only the bidder with the lowest offer (Fox) was allowed to make an increased bid. In the second round, only the bidder that was not eligible to make an offer in the first round (Comcast) was allowed to make an increased bid. If the auction was not concluded after the second round (i.e., if Comcast increased its bid in round two, thus extending the auction), there would be a final round, in which both bidders may make an increased final offer.

The auction went the distance, with both Comcast and Fox increasing their offers and making their best-and-final bids in round three. The final price Fox offered (with permission from Disney) was £15.67, and the final price Comcast offered was £17.28. Under UK takeover code, neither of these offers could be re-raised, and the prices were published by the UK takeover panel on the evening September 22. Ultimately, Comcast’s final bid represented a 60% increase over Fox’s original offer from December 2016.

What’s Next?

While Comcast’s offer is clearly superior to Fox’s, it stipulates a 50% acceptance condition. Fox had publicly stated it was still assessing its options regarding its existing 39% ownership stake. If Fox decided to maintain its stake, Comcast would have needed an 82% acceptance rate across the rest of the shareholder base to be successful in taking control of Sky. (While we believed this was achievable given the superiority of Comcast’s offer, some risk of slippage nonetheless remained. Subsequently, news emerged that Comcast had acquired over 30% of Sky on the open market and that Fox – with permission from Disney – had decided to sell its stake to Comcast, thus satisfying the acceptance condition and helping the transaction move closer to wholly unconditional as per UK takeover code.) We continue to monitor the position and will look to re-add in the event we are able to capture an appropriate spread to the final deal terms.

Water Island UK, Ltd. Is a wholly-owned subsidiary of Water Island Capital, LLC. View top ten holdings.

Mergers & Acquisitions (M&A)

With $1.17 trillion of M&A announced by US firms year-to-date, 2018 remains on track to surpass 2015's record-setting volumes. Despite headlines related to global trade disputes, we have seen several large and significant transactions announced over the past few weeks across various industries. In the Real Estate Investment Trust (REIT) space, Brookfield Asset Management announced that it will acquire Forest City Realty Trust for $25.35 in cash per share. The trend towards REIT deals has been triggered by selling in the sector that has pushed many REITs to trade at discounts to their net assets values. We expect this trend will continue. In healthcare, RegionalCare Hospital Partners, owned by Apollo Global Management, entered into a definitive agreement to acquire LifePoint Health for $65 per share. In chemicals, Platform Specialty Products (PAH) agreed to sell its Arysta LifeScience division to UPL Ltd for approximately $4.2 billion in cash. Proceeds from the deal are expected to be used to pay down debt at PAH. Banking consolidation also appears to be accelerating as rising short-term rates and softer regulatory hurdles for community and regional banks benefits the sector. Most recently, FCB Financial Holdings agreed to be acquired by Synovus in a stock-for-stock deal. The transaction was valued at approximately $2.7 billion.

Overall, transactions that require regulatory approval from the Committee on Foreign Investment in the US (CFIUS) or China’s State Administration for Market Regulation (SAMR), such as Rockwell Collins/United Technologies, 21st Century Fox/Disney, and XL Group/AXA, are leading to wider deal spreads. The lack of clarity on the process and the difficulty in assessing political risks have weighed on these deals.

Despite regulatory headwinds that recently impacted some large deals (Time Warner/AT&T, Tribune/Sinclair Broadcasting), The New York Post reported “US regulators believe three national 5G wireless providers are needed to ensure robust competition. … After studying the Sprint-T-Mobile proposal for more than three months, the Department of Justice [DOJ], while not yet making a decision on the merger, now believes three carriers are needed to establish a true competitive marketplace, according to a source with direct knowledge of the thinking within the DOJ.” While this deal isn’t likely to be assessed until 2019, it will attract attention given the level of investor ownership in both the stocks and bonds of the companies involved.

Lastly, the Wall Street Journal recently published an article entitled How Investors Can Cash In on the M&A Boom (subscription required). The piece highlights the use of merger arbitrage funds as a way to capitalize on the rise in merger and acquisitions, and notes that a rising interest rate environment could lead to more favorable deal spreads.

Credit

Last week, Jamie Dimon, Chairman and CEO of JPM Chase, made headlines when he noted that investors should be prepared for a 5% 10-year yield. While Dimon’s comment did not contain any suggestion of a timeframe to reach such a yield, it certainly highlighted a known tail risk in the market.

Even prior to Dimon’s weekend comments, fixed income investors were concerned about rising interest rates, particularly amid solid US economic growth and the prospect of inflation. The primary solution for cautious fixed income investors has been to increase allocations to floating rate products, such as levered loans, or to invest in short-duration credit as higher short-term rates appear more compelling relative to longer-term yields. Consequently, flows to levered loan and short-duration funds has risen during 2018, and levered loans have outperformed high yield bonds year-to-date.

Investor demand for floating rate bank loans provided cheaper financing for many companies, but lending standards have weakened in the process. Since June, the trend toward loan issuance has taken a pause as investors push back on terms. This has pushed issuers to tap the high yield bond market again for capital, but the excess supply could create a negative impact on credit spreads. This could ultimately lead to opportunities to purchase new issues bonds with more attractive terms.

We think both the levered loan and high yield bond markets will remain active in the near-term as private equity (PE) funds have plentiful cash reserves, evidenced by KKR’s purchased of BMC Software and Envision Healthcare, Apollo’s purchase of Lifepoint Healthcare, and various smaller PE acquisitions including Mitel, Essendant, and Web.com.

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