As illustrated by the failure of Philip Green’s bid for Marks & Spencer and Permira’s bid for WH Smith, the already complex process of negotiation that typify merger and acquisition activity has recently become that bit more complex as pension scheme trustees start to flex their new-found muscles to assume an integral role in determining the success or failure of a bid for the ownership of a company.
In the case of Mr Green’s bid for M&S, for example, a key determinant of its failure was the fact that trustees arrived at the conclusion that, with the company pension scheme having run up a substantial deficit, should Green’s bid be successful, M&S’s credit rating would fall. It would therefore be more highly geared and be considered by analysts to be a riskier business.
As M&S could therefore be considered a less secure investment, the trustees concluded that the strength of the sponsoring employer’s undertaking was not as high. The trustee therefore felt that it was probable that a more cautious investment approach would need to be adopted, with proportionately more assets held in lower risk investments such as bonds, which would in turn lead to a requirement for higher employer contributions. Compounding this, the trustees considered that the period over which the deficiency would be made good should be reduced because of the increased risk, again increasing the contribution burden.
This resulted in the trustees making it known that, were the acquisition of M&S to proceed, they would be looking for a substantial increase in contributions. Prior to last June, a potential purchaser might have just shrugged off such comments from trustees, but the balance of power has since shifted and purchasers can no longer afford to ignore trustees’ views.
The reason for this change is that, prior to June 03, whenever a pension scheme was wound up, the obligation on the employer was not overly onerous with the requirement only to provide transfer values for non pensioners. Post June 03, however, the requirement is now for employers to buy out the scheme members’ pension benefits in full.
This means that where trustees have the power to determine contribution levels and notify employers of the level of contribution they require, prior to June employers could afford to simply ignore trustees’ demands and trustees would have been relatively powerless to argue their case. Post June 03, however, employers are less able to point blank refuse demands from trustees as the threat of scheme wind up means that all the pension scheme benefits must now be secured so that the cash call on the employer of any schemes operating at a deficit on an ongoing basis will be imminent as well as potentially substantial.
Trustees played a central role too in the collapsed bid for WH Smith by private equity company Permira. Adopting a highly leveraged, highly geared buyout strategy, trustees concluded that this would increase substantially WH Smith’s debt burden.
Consequently, the initial response from trustees was to point out that, as a result of all this debt, in the event of the business failing, the pension scheme would be unlikely to receive much cash as a non-preferential creditor and so demanded a cash payment up front by way of compensation. Whilst the trustees did revise their ‘want list’ in terms of contributions it was not enough to get the negotiations back on track.
This evident rise in the power of trustees has made M&A activity much more complex through the introduction of a third party into the negotiations whose interests completely differ to those of the purchaser and vendor. It seems likely that, whilst there is a general pension scheme deficiency problem throughout the UK, the newly-found influence that trustees can bring to bear on negotiations will remain.
Indeed, the bids for M&S and WH Smith have set a precedent so that trustees of larger schemes will be conscious that they will not be fulfilling their obligations to members if they do not start to flex their muscles and make demands over levels of contributions during M&A negotiations.
One consequence of all this is that it could result in a lowering of the offer price a prospective acquirer is prepared to make for a company to a level below that acceptable to shareholders, as bidders are now more likely to value the pension liabilities by reference to bond yields, when considering the net present value of a target acquisition.