Highly leveraged takeover deal backed by KKR to acquire Yageo rejected by Investment Commission, Taiwan

Asia is living in exciting times.  Ministry of Economic Affairs’ Investment Commission (IC) rejected private equity (PE) fund Orion Investment Co (Orion) US$ 1.6 billion buyout of Yageo Corp (Yageo).  The reasons for rejection given by IC are:

• lack of transparency in deciding acquisition price;
• minority stakeholders’ interests could be at risk because of a lack of transparency in the stake-buying prospectus;
• the debt ratio of the new company (as per the prospectus, after the takeover, Orion planned to delist Yageo from the Taiwan Stock Exchange (TWE) and thereafter merge with it), would surge, given that Orion had borrowed money to buy the shares (this being highly leveraged debt borrowing to the extent of NT$28 billion).

Structure of the proposed deal

Just like many other PE funded deals, in the present deal (Yageo deal), Orion in which Mr. Chen Tie-min holds 54.36% and KKR owns the remaining 45.64%, was planning to take Yageo (a manufacturer of passive components used in electronics) private from the TWE after the acquisition.  Orion was planning to spin off Yageo’s deferent component divisions after delisting and take these divisions to public in the future.

Structure of the Yageo deal is described below in a diagram.

The financing of Yageo deal is a bit-complex and  in stricto sensu, it’s a classic leverage buy-out (LBO) deal- and that’s what was opposed by the IC.  The Yageo deal was financed by- (a) own funds of the offeror; (b) shareholder loans; and (c) loans from local (loans from local Taiwan Banks and foreign banks in Taiwan upto NT$28 billion) and foreign financial institutions (UBS AG and Nomura International were roped in for loans upto US$ 957,745,000). 

Transaction Agreement for financing the Yageo deal

As per the transaction agreement (Transaction Agreement) dated 5 April, 2011 between (a) Mr. Chen Tie-min (Chairman and GM of the Target), HCHEL, SHDL, STHE, HTHL, HTL, Mr. Yoshiro Kubota and TMPC Holdings Limited (Founder Shareholders); (b) CHIL Parent (a holding company established by KKR) (CHIL Parent); and (c) AIHL (a JV between Founder Shareholders (through TMPC Holdings Limited) and CHIL Parent):

(a) On First Closing

• Founder Shareholders to invest US$ 35,566,000 in TMPC Holdings Limited (TMPC HL), and cause TMPC HL to acquire loans from offshore financial institutions in an amount of approx US$ 218,064,000 (Founder Bridge).  TMPC HL to further invest the borrowed money and other cash (equivalent to US$ 253,630,000) in shares issued by AIHL.
• CHIL Parent shall make it investment in AHIL by (i) 145,961,000 P-Notes issued by Citigroup Markets Global Holdings (P-Note Issuer) issued by Yageo; and (ii) all shares of CIHL held by CIHL Parent (CIHL holds 227,700,000 offshore convertible bonds issued by Yageo).
• AHIL, to further take loan (debt financing) from offshore financial institutions through bridge loan agreements to fund the sale of shares in the tender offer.

(b) On Second Closing

After the tendered shares reach minimum shares requirement, prior to the closing of tender offer:

• Further investment by CIHL Parent and TMPC HL and other relevant payments by CHIL Parent.

      (c) On Third Closing

Prior to the record date of merger between Yageo and Orion:

• Further investment by CIHL Parent and TMPC HL and other relevant payments by CHIL Parent.

The Offeror shall further seek debt financing from domestic financial institutions.  Subject to availability and credit limit of such debt financing from domestic financial institutions, Alphard Investments Netherlands, may borrow funds from offshore financial institutions and provide such funds to the Offeror in the form of shareholder loan so as to pay a part of purchase price of the tender offer.

After, due consideration the IC took the view that the Yageo deal is a highly leveraged transaction where load to pay the debt would fall on Yageo after the merger between Yageo and Orion and if any default happens Yageo could not be saved (it must be noted Yageo is one of the leading passive manufacturer of passive electronic component in Taiwan, and perhaps, Taiwanese authority do not want a debt default like situation in Taiwan); and another reason could be that Taiwanese authority wants to protect the shareholders particularly the minority shareholders-who would be forced out of the company pursuant to merger between Yageo and Orion.

Scenario in Indian takeover deals

In a takeover deal involving Indian listed company, provisions of Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (Takeover Code) would be applicable.  Under regulation 16 (xiv) of the Takeover Code: (Contents of the Public Announcements) disclosure to the effect that firm arrangement for financial resources required to implement the offer is already in place, including details regarding the sources of the funds whether domestic, i.e., from banks, financial institutions or otherwise or foreign, i.e., from Non-Resident Indians or otherwise.

Indian regulations are more of disclosure oriented regulations, however in practise the SEBI, may ask for details from the acquirer about the funding sources and if found highly leveraged- I am not sure what and how would SEBI react to this.  As a market practise, in the public announcements made by the acquirer a standard clause is put, which is worded like:

The Acquirers and the PAC propose to finance the Offer through internal accruals, equity infusion and bank borrowings

Further as a market practice, the acquirer takes a certificate from the chartered accountants stating that the acquirers are financially fit to acquire the target company.  In my opinion, SEBI might take the view as taken by IC in the Yageo deal and the LBO structured buyouts might not work in India, given the current market situation and regulatory regime in India.  Additionally, the acquisition financing is not allowed/ permissible under the Indian laws (Indian regulations impose restrictions on the ability of banks in India in relation to acquisition financing, prohibiting them from lending to a borrower, irrespective of whether the borrower is located offshore or onshore).

If suppose, Yageo structured like deal as above comes to SEBI (but removing the aspects of debt financing), SEBI might not take block the deal, as in numerous occasions SEBI has cleared the deals (where the public announcement) states (for e.g., acquisition of Patni Computers by iGate):

The Acquirers and the PAC reserve the right to streamline/restructure the operations, assets, liabilities and/or businesses of the Target Company through arrangement/reconstruction, restructuring, merger (including but not limited to merger with itself or any of its subsidiaries), demerger/delisting of the Shares of the Target Company from the Stock Exchanges and/or sale of assets or undertakings, at a later date. Such decisions will be taken by the boards of Directors of Acquirers and the PAC and/or the Board of the Target Company in accordance with procedures set out by applicable law, and pursuant to business requirements and in line with opportunities or changes in the economic scenario, from time to time. The Acquirers and the PAC will evaluate and consider such proposals from time to time in accordance with the business requirements, if appropriate.