Implications of Billabong study: breaking the break fee limit

It’s been a challenging 18 months for Billabong International. Since early 2012, Billabong has received various acquisition and restructuring proposals and has conducted a public sale/refinancing process without a final outcome. During this time, Billabong’s financial condition has deteriorated with a series of earnings downgrades. In July 2013, in urgent need of funds, Billabong announced that it had agreed to a financing proposal from a consortium advised by private equity firm Altamont and hedge fund GSO Capital.

However, the Altamont consortium proposal was challenged in the Takeovers Panel by hedge funds Centerbridge Partners and Oaktree Capital Management, who held the majority of Billabong’s senior debt. Centerbridge and Oaktree alleged that the Altamont consortium’s proposal contained lock-up devices which were coercive and anti-competitive, and therefore prevented the acquisition of control of Billabong taking place in an efficient, competitive and informed market.

Break fees within financing agreements

The Altamont consortium agreed to provide Billabong with a US$294 million bridge facility and a commitment letter for a replacement long-term facility, which contained a US$40 million tranche convertible – subject to Billabong shareholder approval – into redeemable preference shares (RPS) in Billabong. However, the financing package included the following terms which, among others, Oaktree and Centerbridge submitted were unacceptable:

Bridge facility termination fee. A termination fee of 20% of the principal amount of the bridge facility – amounting to approximately A$65 million, or US$61 million – payable if Billabong completed an alternative financing, or a change of control of Billabong occurred and the bridge was repaid;

Make-whole premium. A mandatory repayment of the long-term facility and payment of a significant “make-whole premium” upon a change of control of Billabong. The premium in the first two years was 10% of the principal amount of the loan, plus the interest that would have been payable during the first two years; and

Convertible tranche interest rate. A 35% interest rate on the convertible tranche of the long-term facility, which reduced to 12% if shareholder approval for conversion to RPS was obtained. The RPS would convert into ordinary shares representing 25% of the fully diluted capital, and consequently shareholder approval was required for issue (Australian Securities Exchange listing rule 7.1) and conversion into ordinary shares (takeovers threshold).

Panel analysis

The Australian Securities and Investments Commission (ASIC) submitted that a A$65 million penalty payment on a change of control would deter any reasonable third party seeking to table an alternative proposal. The Takeovers Panel agreed and considered that the termination fee – representing 54% of Billabong’s equity value prior to the announcement of the Altamont consortium’s proposal – was unacceptable.

The Altamont consortium argued that the make-whole premium was standard lending market practice and was not taken for a control purpose, but rather to compensate the lender for lost future interest upon early repayment of the loan. However, the panel considered that the change of control trigger – as opposed to the other triggers for payment of the premium – made the premium unacceptable because it imposed a substantial financial penalty on Billabong if there was a change of control, and therefore was likely to deter rival control proposals.

The panel also noted that the make-whole premium was not disclosed to the market in Billabong’s initial announcement. Consistent with the panel’s approach in the AMP shopping centre trust case (discussed in the firm’s August 2003 issue of Takeovers Legal Update) the panel thought it should have been. (In the AMP shopping centre trust case, the panel made orders preventing the exercise of undisclosed pre-emptive rights triggered by a change of control.)

The panel considered the convertible tranche interest rate to be a “naked no vote” break fee, because it was in effect a payment triggered by the absence of shareholder approval. The additional interest of A$10 million per year payable if shareholder approval was not obtained was considered by the panel to be unacceptable, as it was likely to coerce shareholders into approving the conversion of the US$40 million loan tranche into RPS.

Prior to making its decision, the panel advised Billabong and the Altamont consortium that it was inclined to make a declaration of unacceptable circumstances, and gave them the opportunity to revise the financing agreements. Billabong and the Altamont consortium agreed to:

• reduce the bridge facility termination fee to less than 1% of the enterprise value of Billabong, and remove the change of control trigger; and
• reduce the make-whole premium to 1% of the principal amount of the long-term facility; and
• remove any financial penalty for Billabong if its shareholders did not approve the issue of the RPS.

On this basis, the panel declined to make a declaration of unacceptable circumstances.

Panel guidance

Panel guidance indicates that break fees in excess of 1% of the equity value of the target are more likely to coerce shareholders to accept a bid or deter other potential bidders. However, the panel has in the past considered that a break fee in excess of the 1% threshold may not be unacceptable if, for example, it has been agreed after a public tender process designed to elicit control proposals and the triggers are not unreasonable (see Ausdoc Group [2002] ATP 9, where a fee of 1.9% was permitted). Further, the panel has indicated that potential lock-up devices, which secure a deal, may not be unacceptable where a target is in urgent need of funds, had made efforts to seek alternative funding and believed that there was limited likelihood of a competing proposal emerging (see Mission NewEnergy [2012] ATP 19, discussed in the firm’s 26 October 2012 issue of Takeovers Legal Update).

The fact that there has been a long competitive process and/or the target is in significant financial distress may still justify fees in excess of the 1% benchmark on occasion. However, the panel’s decision in Billabong is a salutary reminder that increasing the size of the break fee demanded, beyond a certain point, also increases the risk of a successful challenge by the panel. A fee of, say, a few percent might well give an acquirer/financier greater comfort than something more ambitious.

Marie McDonald is a partner, and Soon Chin Yeoh is a senior associate at Ashurst in Melbourne. The key contact for this column is Michael Sheng, a partner at Ashurst in Shanghai