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Mar 16, 2009

Box of tricks

Tim Human's monthly M&A roundup

One corporate finance maneuver that has UK investors and shareholders hot under the collar recently is the cash box transaction. At the start of the year, two London-listed companies, Tullow Oil and Autonomy, used this maneuver to issue new shares worth just under 10 percent of their respective market caps, allowing them to avoid having to preemptively offer the shares to existing investors.

UK rules allow companies to raise up to 5 percent in cash and avoid preemption rights. But this rises to 10 percent if the new stock is used to acquire assets.

A cash box structure creates an offshore subsidiary of the issuer, which bankers stuff full of cash. The company then acquires the share capital of the subsidiary. As the issuer is technically acquiring assets, not cash, it can raise more capital without triggering the right to preemption.

The principle of preemption may be unheard of in many parts of the world, but in the UK it is much cherished. Indeed, the Pre-Emption Group was established in 2005 to help protect this right and reports regularly on avoidance tactics.

Following the actions of Tullow Oil and Autonomy, the Association of British Insurers (ABI), which represents big British investors, expressed its concern over ‘recent developments’, as did the UK Shareholders’ Association, which speaks for retail holders. A number of investors also made their objections known.

But the criticism was not split equally between the two firms: Tullow Oil had far more of the negative coverage. Some of its investors were quoted in the press warning other companies not to follow its example. Autonomy’s placing, on the other hand, passed with little comment.

One explanation for this is the reason the two companies had to raise capital in the first place. Autonomy needed cash to fund an acquisition. It carried out its placing on the same day it announced an agreement to buy Interwoven, a California-based IT firm, for $775 mn. The purchase will be funded partly by the share placing, and partly by a new revolving credit facility of up to $200 mn from Barclays. By contrast, Tullow Oil wanted to strengthen its balance sheet and finance operations in Ghana and Uganda.

The UK’s investment community generally accepts the use of cash box transactions as long as proceeds are used to fund a specified takeover, as the cash raised is ultimately for acquiring assets. A company might do this to pay a target in cash, rather than shares.

Shareholder groups say a problem arises when cash boxes are used as a way to raise cash where there is no underlying acquisition, just to circumvent preemption rules. For companies considering a cash box transaction, lawyers warn that issuers should give consideration as to whether consultation with shareholder groups is required. 

Plenty more cash box issues are predicted in the coming months as companies raise equity to repair shaky balance sheets and snatch up distressed rivals. As IR magazine was going to press, the market was abuzz with rumors of capital raisings.

Naturally UK investors and their spokespeople will look to protect their right to preemption as much as possible. Peter Montagnon, ABI chairman, has said he will discuss recent capital raisings ‘with the underwriting community’. Regardless of whether or not there is an acquisition on the cards, however, it would seem harsh to punish issuers for using the most efficient method of capital raising available at a time when the markets continue to yo-yo disconcertingly.

Details correct at time of going to press.